Estate of Owen K Murphy v. Minister of National Revenue, [1973] CTC 2079, 73 DTC 76

A W Prociuk (orally):—The executors and trustees of the estate of Owen K Murphy filed an appeal from the Minister’s assessment dated October 23, 1970 wherein estate tax in the sum of $55,372.14 was levied against them in their representative capacity. The deceased was an American citizen, resident and domiciled in the State of Pennsylvania, one of the United States of America. Prior to his death he was the principal officer, director and shareholder of Monarch Massage Equipment Ltd, a corporation incorporated under the laws of the Province of Ontario in Canada, hereinafter referred to as “Monarch”. He owned 100 common, no par value shares therein, that being the total capital structure. He was also a majority shareholder of Niagara Therapy Manufacturing Corporation hereinafter called “Niagara”, an American corporation incorporated in the State of Delaware with its principal offices in Brocton, New York, USA. Its original capital structure was 500,000 common shares of a par value of $2 per share. An agreement dated May 6, 1968, entered into by Niagara, Monarch and the deceased, provided as follows:

AGREEMENT AND PLAN OF REORGANIZATION

This agreement made and entered into

BY AND BETWEEN

NIAGARA THERAPY MANUFACTURING CORPORATION, a Delaware corporation, having its principal office at Brocton, New York (herein called “Niagara”), first party,

AND

MONARCH MASSAGE EQUIPMENT, LTD (Private Company), incorporated under the laws of the Province of Ontario, Dominion of Canada, having its principal office at Fort Erie, Canada (herein called “Monarch”), second party,

AND

OWEN K MURPHY (herein called “‘Murphy’’), of Adamsviile, Crawford County, Pennsylvania, third party.

WITNESSETH:

WHEREAS, Monarch has issued and outstanding 100 shares. of common capital stock, of which Murphy owns 98 shares and is also the beneficial owner of the remaining two shares held respectively by Charles E Murphy, Jr and Richard A Morrison as nominees for Murphy; and

WHEREAS, Murphy owns in excess of fifty percent (50%) of the issued and outstanding common capital stock of Niagara and by reason of such affiliation Monarch and Niagara have for many years conducted their business operations as affiliates in the sale and distribution of Niagara Cyclo Massage Equipment; and

WHEREAS, Niagara desires to acquire all of the issued and outstanding common capital stock of Monarch in order to operate the said company as a wholly-owned subsidiary to effect economies in advertising, administrative, selling and manufacturing expenses as well as to eliminate potential conflicts with minority stockholders; and

WHEREAS, Niagara desires to acquire the said 100 shares of common capital stock of Monarch from Murphy in exchange for voting stock of Niagara pursuant to a Plan of Reorganization in accordance with Section 368(a)(1)(B) and Section 354 of the Internal Revenue Code of 1954, as amended, under the terms and conditions herein set forth; and

WHEREAS, the parties intend that this Agreement shall constitute a Plan of Reorganization under said provisions.

NOW, THEREFORE, in consideration of their mutual covenants and intending to be legally bound hereby, the parties agree as follows:

1. On the closing date as hereinafter provided, Murphy shall transfer assign and set over unto Niagara 98 shares of the common capital stock of Monarch and shall cause the said Charles E Murphy, Jr and Richard A Morrison to transfer the remaining two shares of common capital stock of Monarch to Niagara, constituting all of the issued and outstanding shares of the common capital stock of Monarch.

2. Simultaneously on the closing date as hereinafter provided, Niagara shall issue to Murphy 100,000 shares of the common capital stock of Niagara in exchange for the shares of Monarch transferred to Niagara as provided in Paragraph 1.

3. The aforesaid exchange shall not be consummated unless and until a ruling has been issued by the Internal Revenue Service determining that said exchange is tax free pursuant to Section 368(a)(1)(B) and Section 354 of the Internal Revenue Code of 1954, as amended, and is likewise in compliance with Section 367 of said Code, and the parties agree to proceed immediately upon the execution of this Agreement to apply for the said ruling.

4. Closing of the above exchange shall take place not later than thirty (30) days from the receipt of a favorable ruling from the Internal Revenue Service as provided in Paragraph 3.

5. In the event that a favorable ruling as above provided cannot be obtained, this Agreement shall thereupon be deemed null and void and neither party shall have any further liability to the other.

6. Since Niagara and Monarch are presently affiliated corporations manufacturing and selling Niagara Cyclo Massage Equipment in the United States and Canada respectively, the parties acknowledge a complete familiarity with the financial condition and business transactions of both Niagara and Monarch. Consequently, the parties have waived warranties and other representations concerning the financial condition and business activities of the said corporations.

7. Each of the corporate parties agrees to cause corporate resolutions of their respective Board of Directors to be duly adopted at a special meeting of their respective Board of Directors convened for the purpose of approving and adopting the within Plan of Reorganization.

8. This Agreement shall be binding upon and inure to the benefit of the parties hereto, their heirs, legal representatives, successors and assigns.

WITNESS the due execution here of this 6th day of May, 1968.

This agreement was filed as Exhibit A-1, Tab 2. There is also a letter dated June 14, 1968 from Leonard Boreman, Esq, of Pittsburgh, Pennsylvania, USA, attorney-at-law for all three parties, written to the Commissioner of Internal Revenue, Washington, DC, USA, requesting that the said advance ruling be made and the said letter is as follows:

June 14, 1968

Commissioner of Internal Revenue

Internal Revenue Building

Washington DC. 20024

Re: (1) Request for advance ruling as required by Section 367 of the

Internal Revenue Code of 1954, as amended, in the case of a reorganization involving a foreign corporation.

(2) Reorganization of Niagara Therapy Manufacturing Corporation and Monarch Massage Equipment Limited, pursuant to Section 368a(1)(B) of the Internal Revenue Code of 1954, as amended.

Dear Sir:

Your ruling is respectfully requested as to the federal income tax consequences of a reorganization of the above-named corporations, pursuant to provisions of Section 368a(1)(B) of the Internal Revenue Code of 1954, as amended. As provided in Section 367 of the Internal Revenue Code of 1954, an advance ruling is required inasmuch as Monarch Massage Equipment Limited is a foreign corporation.

BACKGROUND FACTS CONCERNING CORPORATE PARTIES:

A. Niagara Therapy Manufacturing Corporation:

(1) Niagara Therapy Manufacturing Corporation (hereinafter called ‘Niagara’), is a corporation organized in the State of Delaware, having its principal office in Brocton, New York, and filing its tax returns with the District Director for Buffalo, New York. This taxpayer’s account number is 25-0988992.

(2) Niagara presently has an authorized capital structure of 500,000 shares of common stock, par value $2.00 per share, of which 458,678 shares are presently issued and outstanding. The corporation is presently in the process of amending its charter to provide for an authorized capital stock of 1,000,000 shares of common stock, having a par value of $1.00 per share. The stock of Niagara is not listed on any Exchange. Owen K Murphy is the principal stockholder, owning 50% of the corporation’s issued and outstanding shares. The remaining stock is primarily held by the officers and employees of Niagara.

(3) Niagara is engaged in the manufacture and sale of electrical massage equipment and has been engaged in such activities since its incorporation in 1952.

(4) The books of account of Niagara are maintained on a calendar year basis. Niagara computes its income under the accrual method of accounting. A balance sheet and profit and loss statement for the year ended December 31, 1967, is attached hereto and designated as Exhibit “A”.

B. Monarch Massage Equipment Limited:

(1) Monarch Massage Equipment Limited (hereinafter called ‘Monarch’) is a corporation organized in the Province of Ontario, Dominion of Canada, having its principal office at Fort Erie, Canada.

(2) Monarch ‘has an authorized capital structure of 100 shares of common stock, having no par value, of which 100 shares are presently issued and outstanding. Owen K Murphy is the owner of 98 shares and is also the beneficial owner of the remaining two shares held, respectively, by Charles E Murphy, Jr and Richard A Morrison, as nominee for Owen K Murphy.

(3) Monarch is engaged in the manufacture and sale of electrical massage equipment and has been engaged in such activities since its incorporation in 1955.

(4) The books of account of Monarch are maintained on a calendar year basis. Monarch computes its taxable income under the accrual method of accounting. A balance sheet and profit and loss statement for Monarch for the year ended December 31, 1967, is attached hereto as Exhibit “B”.

BUSINESS PURPOSE OF PROPOSED REORGANIZATION

1. As may be noted from the foregoing, Owen K Murphy is the sole shareholder of Monarch and the majority shareholder of Niagara. In addition, it should be noted that both corporations manufacture and sell identical products, pursuant to patents owned by Niagara. For its existence Monarch relies upon the ability to use the patents of Niagara.

2. The proposed reorganization will enable Niagara to effect desirable changes in the administration, control and operation of both Niagara and Monarch, effect economies to administration, and provide a better basis for allocating production and distribution between the two companies.

3. Niagara is considering a public issue of its stock in the near future and the parties feel that the offering will be enhanced if Monarch is a wholly owned subsidiary of Niagara.

4. Owen K Murphy has indicated a desire to transfer all of the stock of Monarch to Niagara in exchange for 100,000 shares of the common stock of Niagara when such stock has been authorized. The book value of the stock of each corporation to be transferred is approximately equal. This action has been approved by the shareholders of Niagara and of Monarch and an Agreement and Plan of Reorganization has been entered into between the parties, which Agreement and Plan of Reorganization has been entered into between the parties, which Agreement is subject to a favourable ruling from the Commissioner of Internal Aevenue. A true and correct copy of said Agreement is attached hereto and made a part hereof as Exhibit “C”.

5. The operations of both Monarch and Niagara will be continued on an unchanged basis.

6. Niagara does not now intend to consider the sale of stock of Monarch to be received from Owen K Murphy nor has Niagara entered into any negotiations with respect to such a potential sale. Owen K Murphy does not now intend to consider the sale of stock of Niagara to be received pursuant to the proposed reorganization, nor has Owen K Murphy entered into any negotiations with respect to such potential sale. It is the intention of the parties that both corporations will operate as separate entities, with Monarch being a wholly owned subsidiary of Niagara.

REQUEST

Based on the foregoing, a Ruling is respectfully requested to the effect that:

1. The reorganization between Niagara and Monarch constitutes a reorganization pursuant to Section 368a(1)(B) and both Niagara and Monarch qualify as parties to a reorganization under Section 368(b).

2. The reorganization between Niagara and Monarch, a foreign corporation, is approved pursuant to Section 367 of the Internal Revenue Code, as amended.

3. The exchange of all of Monarch’s stock for stock of Niagara will not give rise to the recognition of taxable gain or deductible loss under Section 354.

4. The stock of Niagara to be received by the present Monarch shareholder in exchange for the stock in Monarch will carry with it, in each case, the tax basis formerly applicable to the Monarch shares owned, in accordance with the provisions of Section 358(a).

PROCEDURAL STATEMENT

Please send a copy of the Ruling Letter to the undersigned in accordance with the enclosed Power of Attorney.

If information is desired, please telephone the undersigned collect.

The issues pending herein are not now pending before any field office of the Internal Revenue Service.

A conference is hereby requested if any decision should be under consideration, inconsistent with any of the foregoing ruling requests, before any such decision is made.

Respectfully,

Leonard Boreman

The deceased died on or about August 25, 1968. The ruling requested was made by the United States Treasury Department on or about December 9, 1968. The respondent took the position that the deceased was the legal and beneficial owner of the said shares in Monarch immediately prior to his death and therefore the property passed on his death within the meaning of section 3, subsection (1) of the Estate Tax Act. Further, the said shares were situate in Canada within the meaning of paragraph 38(e) of the said Act. Learned counsel for the respondent argued that clause 3 of the agreement created a true condition precedent and until a favourable ruling was obtained, there was no right to specific performance on either side. He further argued that the condition precedent could not be waived.

Learned counsel for the appellants argued that by virtue of the agreement the deceased, while being the registered owner of the shares at the time of his death, merely held them in trust for Niagara, the beneficial owner thereof and therefore not subject to the provisions of the Canadian Estate Tax Act.

Mr Boreman aforesaid, testified as one of the appellants. Evidence was lead as to his qualifications and I have no hesitation in accepting him as learned in the law of the State of Pennsylvania, a specialist in the United States tax law and one with considerable court experience in his State as well as in the American Federal Courts. He stated that the basis of Pennsylvania law was British common law. In his opinion the law affecting conditions precedent and waivers thereof had not been altered by statute in the State of Pennsylvania. He suggested that in Pennsylvania a condition precedent could be waived by the party for whose benefit it was made and that party entitled to succeed in an action for specific performance on the remainder of the contract. He did not, however, cite any Pennsylvania case law nor argue that the terminology used in the agreement aforesaid would be given any different interpretation in that State than by any Canadian court of competent jurisdiction, including this Board. In his evidence he stated that the condition precedent in the agreement was solely for the benefit of the deceased and it could have been waived by him at any time. He further stated that the request for a ruling was a mere formality as he felt certain that a favourable ruling would be obtained in due course.

On a careful review of evidence and the documents filed by the appellants in support of their contentions, I do not agree that the request for a ruling by the United States Treasury Department was solely for the benefit of the deceased nor was it a mere formality.

Paragraphs 3, 4 and 5 of the agreement are clearly set out and the meaning of each is unequivocal. No beneficial rights accrued nor were intended to accrue to any party until a favourable ruling was obtained. I am also of the opinion that the condition precedent herein could not be waived unilaterally as there was no right to be waived prior to a favourable ruling.

I agree with counsel for the respondent that until the condition precedent was fulfilled, that is to say, until the United States Treasury Department gave a favourable ruling, there was no right to specific performance on either side. It follows that the beneficial ownership by the deceased of Monarch stock prior to his death was in no way affected by the agreement of May 6, 1968. The appeal accordingly is dismissed.

Appeal dismissed.