Corporate Liquidations: The Kimbell-Diamond Doctrine — May It Rest in Peace

Chrome Plate, Inc. v. District Director of Internal Revenue, 614 F.2d 990 (5th Cir. 1980). Due to the pressures of the Great Depression and the financial collapse of many businesses, President Franklin Roosevelt felt a need for the simplification of corporate structures. Congress reacted to this need for simplification and accordingly adopted section 112(b)(6) of the Revenue Act of 1935. This section, which was carried forward into the 1939 Internal Revenue Code with only a few alterations, provided for the tax-free liquidation of a corporate subsidiary, allowing the nonrecognition of gain or loss. The tax basis for the assets of a liquidated subsidiary under section 112(b)(6) in the 1939 Code was governed by section 113(a)(15) of the Revenue Act of 1936.This basis provision called for the parent company completely liquidating its subsidiary to carry over the subsidiary\u27s basis in its assets. After section 112(b)(6) was enacted, if a parent corporation fell within this provision\u27s framework, it could not realize the true value of the subsidiary\u27s assets as indicated by the purchase price of the subsidiary\u27s stock. The parent corporation was bound by the carryover basis as prescribed in section 113(a)(15). To avoid this predicament, corporations attempting to use cost or stepped-up basis for the subsidiary\u27s assets have argued that by purchasing the stock, and shortly thereafter liquidating the subsidiary, it was their primary intent to obtain the assets of the subsidiary. They have insisted that the multiple steps involved in obtaining the assets should be treated as a single, integrated transaction. In the landmark case of Kimbell-Diamond Milling Co. v. Commissioner, which exalted the “single transaction” doctrine, the Commissioner successfully claimed that the basis for the subsidiary\u27s assets should be the cost of the subsidiary\u27s stock. The Tax Court found that since it was the parent\u27s intent to purchase the assets of the subsidiary, the multiple steps involved in liquidating the subsidiary should be viewed as a single transaction. This doctrine, which is now referred to as the Kimbell-Diamond doctrine, was based on the fundamental tax concept that the substance of a transaction should prevail over its form. Thus, the provision covering complete liquidation of a subsidiary originated as section 112(b)(6) of the Revenue Act of 1935. The same section, with minor alterations, appeared in the Internal Revenue Code of 1939. It was carried forward into the 1954 Code as section 332. The provision for determining the basis of a liquidated subsidiary, found in section 113(a)(15) of the 1939 Code, was expanded in sections 334(b)(1) and (b)(2) of the 1954 Code. In general, section 334(b)(1) provides for a carryover basis, but section 334(b)(2) provides a cost basis exception. The 334(b)(2) exception included “rules effectuating principles derived from Kimbell-Diamond Milling Co. …” This codification of the Kimbell-Diamond, single transaction doctrine, provides a “mechanistic approach” for acquiring a stepped-up basis in a subsidiary\u27s assets. The enactment of section 334(b)(2) has caused considerable controversy concerning the viability of the Kimbell-Diamond doctrine. Can the court-created doctrine, which is based on the subjective intent of the parent corporation at the time of liquidation, survive in light of the formalistic, objective requirements of section 334(b)(2)