397 U.S. 301 (1970), 282, United States v. Davis
|Docket Nº:||No. 282|
|Citation:||397 U.S. 301, 90 S.Ct. 1041, 25 L.Ed.2d 323|
|Party Name:||United States v. Davis|
|Case Date:||March 23, 1970|
|Court:||United States Supreme Court|
Argued January 12, 1970
CERTIORARI TO THE UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT
Taxpayer organized a corporation with one Bradley, who received 500 shares of common stock (later sold to taxpayer and divided between two of his children), taxpayer and his wife each receiving 250 shares. To increase the company's working capital and qualify for an RFC loan, taxpayer bought 1,000 shares of preferred stock, at a par value of $25 per share, which the company (in accordance with the original understanding) redeemed when the loan was paid. Taxpayer treated the transaction for income tax purposes as a sale of preferred stock, resulting in no gain to him, since the stock's basis was $25,000. The Commissioner of Internal Revenue determined that the distribution of that sum was essentially equivalent to a dividend, and reportable as ordinary income under §§ 301 and 316 of the Internal Revenue Code of 1954. That determination was premised on the Commissioner's finding that, by reason of the rules of attribution in § 318(a) of the Code (under which a taxpayer is considered to own the stock owned by his spouse and children), the taxpayer here must be deemed the owner of all the company's stock immediately before and after the redemption. The taxpayer paid the resulting deficiency and brought this suit for a refund. The District Court ruled in the taxpayer's favor. The Court of Appeals affirmed, holding that the $25,000 received by the taxpayer was the final step in a course of action with a legitimate business purpose, and thus "not essentially equivalent to a dividend" within the meaning of § 302(b)(1) of the Code, which qualified the distribution as a "payment in exchange for the stock" and entitled it to capital gains, rather than ordinary income, treatment under § 302(a). Taxpayer contends that the attribution rules do not apply for the purpose of § 302(b)(1); that he should be considered to own only 25 percent of the corporation's common stock, and that the distribution would qualify under § 302(b)(1), since it was not proportionate to his stock interest, the fundamental test of dividend equivalency.
1. The attribution rules of § 318(a) apply to all of § 302, and, for the purpose of deciding whether the distribution here is
"not essentially equivalent to a dividend" under § 302(b)(1), taxpayer must be deemed the owner of all 1,000 shares of the company's common stock. Pp. 304-307.
2. Regardless of business purpose, a redemption is always "essentially equivalent to a dividend" within the meaning of § 302(b)(1) if it does not change the shareholder's proportionate interest in the corporation. Since taxpayer here (after application of the attribution rules) was the corporation's sole shareholder both before and after the redemption, he did not qualify for capital gains treatment under that test. Pp. 307-313.
408 F.2d 1139, reversed and remanded.
MARSHALL, J., lead opinion
MR. JUSTICE MARSHALL delivered the opinion of the Court.
In 1945, taxpayer1 and E. B. Bradley organized a corporation. In exchange for property transferred to the new company, Bradley received 500 shares of common stock, and taxpayer and his wife similarly each received 250 such shares. Shortly thereafter, taxpayer made an additional contribution to the corporation, [90 S.Ct. 1043] purchasing 1,000 shares of preferred stock at a par value of $25 per share.
The purpose of this latter transaction was to increase the company's working capital, and thereby to qualify for a loan previously negotiated through the Reconstruction Finance Corporation. It was understood that the corporation would redeem the preferred stock when
the RFC loan had been repaid. Although, in the interim, taxpayer bought Bradley's 500 shares and divided them between his son and daughter, the total capitalization of the company remained the same until 1963. That year, after the loan was fully repaid and in accordance with the original understanding, the company redeemed taxpayer's preferred stock.
In his 1963 personal income tax return, taxpayer did not report the $25,000 received by him upon the redemption of his preferred stock as income. Rather, taxpayer considered the redemption as a sale of his preferred stock to the company -- a capital gains transaction under § 302 of the Internal Revenue Code of 1954 resulting in no tax, since taxpayer's basis in the stock equaled the amount he received for it. The Commissioner of Internal Revenue, however, did not approve this tax treatment. According to the Commissioner, the redemption of taxpayer's stock was essentially equivalent to a dividend, and was thus taxable as ordinary income under §§ 301 and 316 of the Code. Taxpayer paid the resulting deficiency, and brought this suit for a refund. The District Court ruled in his favor, 274 F.Supp. 466 (D.C.M.D.Tenn.1967), and, on appeal, the Court of Appeals affirmed. 408 F.2d 1139 (C.A. 6th Cir.1969).
The Court of Appeals held that the $25,000 received by taxpayer was "not essentially equivalent to a dividend" within the meaning of that phrase in § 302(b)(1) of the Code because the redemption was the final step in a course of action that had a legitimate business (as opposed to a tax avoidance) purpose. That holding represents only one of a variety of treatments accorded similar transactions under § 302(b)(1) in the circuit courts of appeals.2 We granted certiorari, 396 U.S. 815 (1969),
in order to resolve this recurring tax question involving stock redemptions by closely held corporations. We reverse.
The Internal Revenue Code of 1954 provides generally in §§ 301 and 316 for the tax treatment of distributions by a corporation to its shareholders; under those provisions, a distribution is includable in a taxpayer's gross income [90 S.Ct. 1044] as a dividend out of earnings and profits to the extent such earnings exist.3 There are exceptions to the application of these general provisions, however, and among them are those found in § 302, involving certain distributions for redeemed stock. The basic question in this case is whether the $25,000 distribution by the corporation to taxpayer falls under that section -- more specifically, whether its legitimate business motivation qualifies the distribution under § 302(b)(1) of the Code.
Preliminarily, however, we must consider the relationship between 302(b)(1) and the rules regarding the attribution of stock ownership found in § 31(a) of the Code.
Under subsection (a) of § 302, a distribution is treated as "payment in exchange for the stock," thus qualifying for capital gains, rather than ordinary income treatment, if the conditions contained in any one of the four paragraphs of subsection (b) are met. In addition to paragraph (1)'s "not essentially equivalent to a dividend" test, capital gains treatment is available where (2) the taxpayer's voting strength is substantially diminished, (3) his interest in the company is completely terminated, or (4) certain railroad stock is redeemed. Paragraph (4) is not involved here, and taxpayer admits that paragraphs (2) and (3) do not apply. Moreover, taxpayer agrees that, for the purposes of §§ 302(b)(2) and (3), the attribution rules of § 318(a) apply, and he is considered to own the 750 outstanding shares of common stock held by his wife and children in addition to the 250 shares in his own name.4
Taxpayer, however, argues that the attribution rules do not apply in considering whether a distribution is essentially equivalent to a dividend under § 302(b)(1).
According to taxpayer, he should thus be considered to own only 25 percent of the corporation's common stock, and the distribution would the qualify under § 302(b)(1) since it was not pro rata or proportionate to his stock interest, the fundamental test of dividend equivalency. See Treas.Reg. 1.302-2(b). However, the plain language of the statute compels rejection of the argument. In subsection (c) of § 302, the attribution rules are made specifically applicable "in determining the ownership of stock for purposes of this section." Applying this language, both courts below held that § 318(a) applies to all of § 302, including § 302(b)(1) -- a view in accord with the decisions of the other courts of appeals,5 a longstanding treasury regulation,6 and the opinion of the leading commentators.7
Against this weight of authority, taxpayer argues that the result under paragraph (1) should be different because there is no explicit reference to stock ownership, as there is in paragraphs (2) and (3). Neither that fact, however, nor the purpose and history of § 302(b)(1) supports taxpayer's argument. The attribution rule designed to provide a clear answer to what would otherwise be a difficult tax question -- formed part of the tax bill that was subsequently enacted as the 1954 Code. As is discussed further infra, the bill as passed by the House of Representatives contained no provision comparable to § 302(b)(1). When that provision was added in the Senate, no purpose was evidenced to restrict the applicability of § 318(a). Rather, the attribution rules
continued to be made specifically applicable to the entire section, and we believe that Congress intended that they be taken into account wherever ownership of stock was relevant.
Indeed, it was necessary that the attribution rules apply to § 302(b)(1) unless they were to be effectively eliminated from consideration with regard to §§ 302(b)(2) and (3) also. For if a transaction failed to qualify under one of those sections solely because of the attribution rules, it would, according to taxpayer's argument, nonetheless qualify under § 302(b)(1). We cannot agree that Congress intended so to nullify its explicit directive. We...
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