United States v. Collins
Decision Date | 02 April 1962 |
Docket Number | 5895.,No. 5885,5885 |
Citation | 300 F.2d 821 |
Parties | UNITED STATES of America, Defendant, Appellant, v. R. Perry COLLINS et al., Plaintiffs, Appellees (two cases). |
Court | U.S. Court of Appeals — First Circuit |
Melvyn I. Mark, Atty., Dept. of Justice, with whom Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, A. P. Prescott, and L. W. Post, Attys., Dept. of Justice, W. Arthur Garrity, Jr., U. S. Atty. and William C. Madden, Asst. U. S. Atty., were on brief, for appellant.
Roger P. Stokey, Boston, Mass., with whom Goodwin, Procter & Hoar, Boston, Mass., was on brief, for appellees.
Before WOODBURY, Chief Judge, and HARTIGAN and ALDRICH, Circuit Judges.
Number 5895 is an appeal by the United States of America from a judgment of the United States District Court for the District of Massachusetts entered on June 27, 1961 in favor of the taxpayers in a refund action to recover income taxes and interest alleged to have been illegally assessed and collected.1 The sole question involved on this appeal is whether $15,000 in cash received by taxpayers in 1954 from R. P. Collins & Company, Inc. (a Massachusetts corporation), in exchange for all of the common stock of the Permar Corporation (a Florida corporation) was taxable as ordinary income, as a distribution essentially equivalent to a dividend under Sections 304, 302 and related sections of the Internal Revenue Code of 1954, 26 U.S.C.A. §§ 302, 304.
In 1954 the taxpayers, R. Perry Collins and his wife Marjorie C. Collins owned the entire stock (15,000 shares) of the Permar Corporation (hereinafter called "Permar"). Permar's principal business activity was the ownership and operation of an apartment hotel in Ft. Lauderdale, Florida. Permar had been financed by the issuance of 15,000 shares at $1 a share (all ultimately acquired by taxpayers at that price) and by borrowing $60,000 from Collins on a note. On September 1, 1954, the taxpayers transferred their shares to R. P. Collins & Company, Inc. (hereinafter called the Collins Company), for $15,000 in cash.2
On the date of this transfer the book value of the Permar stock was $12,884.07. On the same date Collins transferred Permar's note having an unpaid principal balance of $55,000 to the Collins Company for $55,000. At this time the Collins Company had an earned surplus of some $523,000. The taxpayers owned 70 per cent of its stock, the remaining 30 per cent was owned by or in trust for the benefit of their daughters.
On their income tax return for the relevant year taxpayers treated this transaction as a sale of property at cost giving rise to no taxable income. The government disputed this treatment contending that the $15,000 was a distribution essentially equivalent to a dividend and, consequently, taxable as ordinary income. Taxpayers paid the additional assessments and brought this action for a refund.
The government's position in this case is predicated on the application of Sections 304 and 302 of the 1954 Code. Section 304 was enacted in the 1954 Code to close loopholes in the tax laws deriving from transactions involving "brother-sister corporations." This involves situations where one or more individuals are in effective control of each of two corporations, and one of the corporations acquires stock of the other corporation. Section 304 provides that if (a) two corporations are controlled by the same persons, and (b) one of the corporations acquires stock in the other corporation which is owned by the person in control, the purchase is then defined as a redemption. Thereafter, Section 302 provides that such a redemption shall be treated as an exchange (and taxed at capital gains rates) if the distribution is not essentially equivalent to a dividend. If, however, the distribution is essentially equivalent to a dividend, then the distribution is taxable at ordinary income rates under Sections 301 and 316 of the Internal Revenue Code, 26 U.S.C.A. §§ 301, 316.
From the outset taxpayers have conceded that the transaction falls within the purview of Section 304 — that Permar and the Collins Company are "brother and sister" corporations within the meaning of the Code. Thus, turning to Section 302 the question which must be answered is whether the $15,000 which flowed from the Collins Company to the taxpayers, in exchange for the Permar stock, more closely resembled payment deriving from the sale of stock in an arm's length bargain or more closely resembled the receipt of a dividend. Bradbury v. Commissioner of Internal Revenue, 298 F.2d 111 (1 Cir.), decided January 15, 1962.
In the district court the government argued that a distribution has the effect of a dividend when the corporation has earnings or profits available for distribution as dividends, the distribution is made pro rata to its stockholders, and the distribution is not made incident to a partial liquidation. The court agreed that "technically all the conditions which the government considers necessary to constitute the payment a dividend are fulfilled." 193 F.Supp. 602, 608. Thus the court recognized that at the time of the instant transaction the Collins Company had an earned surplus of over a half million dollars available for distribution; that the distribution was made pro rata to the stockholders (since under the attribution rules of Section 318 of the Code, 26 U.S.C.A. § 318, Mr. and Mrs. Collins must be regarded as owners of the stock owned by or in trust for their daughters); and that the distribution was not connected with a partial liquidation or contraction of the business.
However, the lower court went on to apply the so-called "net effect" test in determining dividend equivalency and after considering a number of additional factors, to be discussed below, reached the conclusion that the payment of the $15,000 to Mr. and Mrs. Collins in return for the transfer of their Permar stock to the Collins Company was not essentially equivalent to a dividend within the meaning of Section 302.
In its enumeration of the countervailing considerations to dividend equivalence the district court, after noting the initial necessity of a corporation having earnings or profits available for distribution before Section 302 would be applicable, stated: "but it is also essential that these earnings or profits should have been distributed, and thus that there should have been an actual reduction of the corporation's surplus." In concluding that the transaction had produced no reduction in surplus so far as the Collins Company was concerned, the court stated: 193 F. Supp. 602 at 608.
In effect the court held that Section 302 and Section 304 were inapplicable where the stockholders' sale to the corporation was at a fair price or at fair market value.3
We believe that the district judge's emphasis on the fair market value of the transferred stock and on whether the transfer produced a reduction of surplus in the acquiring corporation was misplaced. If a taxpayer owns the entire stock of two corporations and sells his stock in corporation "A" to corporation "B" (extracting cash or property in the process), the economic consequences to the taxpayer are no different than if corporation "B" (the acquiring corporation) had distributed property to him without requiring the surrender of stock, except for the fact (usually devoid of practical consequences) that corporation "B" now holds the stock of corporation "A". See, Bittker, Federal Income Taxation of Corporations and Shareholders (1959), p. 235. Since this is the situation which Section 304 and Section 302 were designed to reach, the question of the "fair price" of the subject stock and its residual impact on the surplus account of the acquiring corporation are of little real significance. Indeed, in this situation, since the taxpayer can control the matter, so long as he insures that the payment for the stock does not exceed fair market value, it would be unusual for the acquiring corporation ever to have a reduction of surplus unless the acquired stock was retired.
However, it is to be noted that Section 317(b) of the 1954 Code, 26 U.S.C.A. § 317(b) expressly provides that for purposes of the tax, stock shall be regarded as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property, whether or not the stock so acquired is cancelled, retired, or held as treasury stock.
Moreover, this identical issue was raised in the case of Radnitz v. United States, 187 F.Supp. 952 (D.C.S.D.N.Y. 1960), aff'd per curiam, 294 F.2d 577 (2 Cir. 1961), where in a similar case it was held that Section 304 of the Code would be applicable even where the sale of stock to the corporation was made at fair market value. In that case the district court stated:
187 F.Supp. 952, 959.
We are in accord with this reasoning and agree with the government that the vitality of Section 304 ought not...
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