Gregory v Helvering (1935) is not the most well-known financial case, yet this Great Depression-era piece of litigation is fascinating for a number of reasons. Perhaps the most notable reason for its appeal is its relevance to more modern financial scandals.
Although this case is almost a century old (1935), there’s been plenty of financial scandals reminiscent of its implications. Take the Enron scandal as an example which can be summed up as an elaborate and complex accounting fraud case; insider trading and other kinds of high-brainpower, white collar underhandedness.
Every trend, no matter its size or significance, can be traced to a single source, and the case of Gregory v. Helvering stands as a legitimate candidate for the forerunner to much of the financial trickery present in recent decades. And this is not necessarily because the taxpayer in the case aimed to abuse the law in a nefarious way. In this case, there was an attempt to transact in such a manner that the form of the law is obeyed but its spirit is ignored. And this creative maneuvering is something that we see again and again in the modern era.
Gregory v Helvering: The Case
Gregory (the taxpayer) owned a company – United Mortgage Corporation – which held 1,000 shares of another company’s stock (Monitor Securities Corporation). Evelyn Gregory wished to sell this stock but also wished to minimize (or ideally eliminate) the potential tax liability of such a sale.
Toward this end, Gregory established a new company, Averill Corporation, and then transferred the 1,000 shares of Monitor Securities to Averill Corp.
From there, Gregory then transferred the 1,000 shares of Monitor to herself, and then dissolved Averill as a company. The Averill entity clearly had no other function aside from acting as a conduit through which to distribute the shares to the taxpayer.
Gregory contended that the series of actions which occurred fell under section 112 of the Revenue Act of 1928 as a corporate “reorganization.” If what occurred were in fact reorganization under section 112, the gain realized by the taxpayer would not be taxable.
What’s the Law Say?
The relevant subsections of 112 were (g) and (i). Subsection (g) stated that distributions of stock on reorganization to a shareholder in a corporation which was a party to the reorganization will not result in gain (to the receiving shareholder). Subsection (i) lays out a definition for what constitutes a reorganization.
Ruling Against Gregory
The U.S. Supreme Court ruled that a legitimate reorganization had not occurred and that the deficiency assessed by the IRS was correct.
Even though the Gregory had apparently satisfied every element of section 112, the court reasoned that section 112 did not apply because the Averill Corporation was clearly a “dummy company” in the sense that it served no other purpose than to eliminate the tax liability which would have normally followed the stock distribution. Hence, though the taxpayer took steps to fall under section 112, what had actually occurred was a dividend, because there was no substance underlying the creation of the Averill Corporation.
What we have here, therefore, is a fascinating early example of creative business maneuvering. The taxpayer either received expert counsel on section 112, or was familiar with section 112 by way of independent research, and the taxpayer established the dummy company for the specific purpose of falling within the meaning of this statute.
Even though Gregory took steps to ensure the transaction would be fulfilled under section 112, the court was not willing to let this type of trickery slide under the judicial radar. In some ways, Gregory v. Helvering represents the embryonic form of more heinous modern trickery, such as the kind perpetrated by Enron’s CFO, Andrew Fastow.
Although what happened here is dwarfed by comparison to modern scenarios, it’s still interesting to see the roots of what goes on around us today.