Agway, Inc. v. United States
| Decision Date | 22 October 1975 |
| Docket Number | No. 302-72.,302-72. |
| Citation | 524 F.2d 1194 |
| Parties | AGWAY, INC., Successor to Cooperative Grange League Federation Exchange, Inc. v. The UNITED STATES. |
| Court | U.S. Claims Court |
Mac Asbill, Jr., Washington, D. C., attorney of record for plaintiff; William A. Sutherland, James F. Jorden, Rufus E. Brown, and Sutherland, Asbill & Brennan, Washington, D. C., of counsel.
Charles E. Auslander, Jr., Washington, D. C., with whom was Asst. Atty. Gen. Scott P. Crampton, for defendant; Theodore D. Peyser, Jr., John E. Evans, Washington, D. C., of counsel.
Before DURFEE, Senior Judge, and NICHOLS and KASHIWA, Judges.
ON DEFENDANT'S MOTION AND PLAINTIFF'S CROSS MOTION FOR SUMMARY JUDGMENT
This tax refund suit for $28,044.19 (and statutory interest) comes before the court on cross motions for summary judgment on the sole remaining issue in the case: whether plaintiff's $43,480 gain on the redemption of preferred stock in an agricultural cooperative is taxable as ordinary income or as capital gains (long-term).
The stock that was redeemed in taxpayer's 1960 fiscal year, at $100 face value per share, was originally issued in 1957, valued by plaintiff and defendant then at $60 per share on audit after extended negotiations, and taken into income at that figure. Plaintiff contends that the $40 per share gain on the redemption of the stock over its 1957 fair market value (FMV) of $60 is either a capital gain or a tax-free, basis-reducing return of capital. Defendant contends that the $40 per share gain is simply ordinary income to plaintiff for a series of reasons discussed below. Plaintiff has paid the tax assessed and sues for refund. We hold for plaintiff that its gain is a capital gain, following the Fifth Circuit decisions in Tomlinson v. Massey, 308 F.2d 168 (1962); and Raley v. United States, 491 F.2d 136 (1974).
Plaintiff is a Delaware corporation, doing business as a farmers' cooperative in New York and successor since July 1, 1964, to Cooperative Grange League Federation Exchange, Inc., which was both organized as a New York corporation and did business in New York. Exchange's principal business for the tax year in question was the manufacture and purchase of farm supplies, equipment and petroleum products and the sale of such items either directly to its farmer patrons or to various retail outlets which, in turn, sold them to farmers. Exchange kept its books on an accrual basis with a July 1-June 30 fiscal year. It is Exchange's 1960 fiscal year (July 1, 1959-June 30, 1960) that is in issue. Hereinafter the word "Exchange" may refer to plaintiff, and vice versa.
Plaintiff was also a patron of United Co-Operatives, Inc., organized as an Indiana farmers' cooperative corporation. United operates on an accrual basis using a November 1-October 31 fiscal year, making its patronage refunds annually on approximately October 31. This case concerns the stock transactions between United and plaintiff.
Article 7 of United's By-laws governed the stock transactions in issue, and so far as relevant provide as follows: (1) Section 5 (of Article 7) makes all capital contributions (including plaintiff's preferred stock before redemption) "subject to all the risks and contingencies incident to the investment of capital in corporations." (2) Section 6 requires patronage refunds to be paid annually on the basis of a single year's volume of business. (3) Section 7 allows patronage refunds to be paid out in a wide variety of forms, including cash, stock, and other "paper". (4) Section 10 requires that capital contributions be assessed on the basis of the last 3 years volume of business. (5) Section 11 allows patronage refunds to be used to meet capital contributions—the patrons receiving "paper" or stock in lieu of cash as a result of crediting patronage refunds to obligatory capital contributions. (6) Section 13 acknowledges the cooperative's obligation to pay back eventually all net margins and capital contributions to the patrons (assuming the cooperative stays solvent). (7) Sections 14 and 15 qualify this pay-back right by reserving to the Board of Directors' judgment the decision when and if to pay back retained profits and capital contributions. Capital advances are retired in the order received.
During Exchange's fiscal year 1960, the following stock transactions with United occurred:
The following table displays the effects of these two stock transactions on Exchange's share of United's preferred stock:
Percentage of
outstanding
Shares stock
Before Oct. 31, 1959 __________ 3,480 17.4
After Oct. 31, 1959 ___________ 5,673 18.0
After Feb. 1, 1960 ____________ 4,586 16.1
During this same fiscal year 1960 Exchange held a constant total of 100 shares of Class A common stock also, which at all times was less than 6% of the outstanding Class A common stock. Exchange held no Class B common stock during this period.
The exclusive voting rights were in the A stock. The C stock (preferred stock) was freely transferrable. It paid dividends not over 4% per annum. On liquidation, the C stock, plus accumulated dividends took precedence over common stock and patronage distributions.
Joint Exhibit K, which lists plaintiff's transactions in the preferred stock (issued as patronage refunds by United) discloses the uncertain nature of preferred stock redemptions:
Preferred Stock Fiscal
Years Issued Redeemed
1942-1953 _________________ About 4,000 shares ____ 42 shares
1954-1956 _________________ None __________________ About 3,000 shares
1957-Jan. 1960 ____________ About 5,700 shares ____ About 1,500 shares
Thus the capital needs of United resulted in Exchange holding about 5,000 shares at the end of 19 years membership in United. All previous redemptions had effectively been cancelled by subsequent stock patronage refunds, prior to the stock redemption here about February 1, 1960. Defendant has offered no specific evidence to establish any motive of tax avoidance or tax evasion in the operation of the above stock issuance and redemption program.
The adjustment on audit of 1957 taxes reflected an addition of $60 a share to plaintiff's ordinary income.
The first substantial issue in this case is to determine the applicable Code Section of Subchapter C of the 1954 Internal Revenue Code (IRC, also Title 26 of U.S.C.).
Although defendant makes a point that we should totally reject Subchapter C, as governing, because United was not a for-profit corporation, no statutory or case law citations are presented to support such an extraordinary contention. Further it is clearly stipulated that plaintiff and United both operated as corporations under their respective state laws. No evidence to support a holding that the corporations were mere shells or dummies is presented. Consequently the defendant's assertions are rejected without further consideration.
Plaintiff presents two alternative arguments: one is that the transactions are to be treated as true capital-gain redemptions under Subchapter C, § 302; the other is that the redemptions are to be treated as non-dividend distributions under § 301. These arguments cannot both be right. Under § 301(a), § 301 does not apply if the chapter otherwise provides. In § 302 it does so otherwise provide (with certain stated exceptions) in the case of a redemption. The definition in § 317(b) holds that if a corporation acquires its stock from a shareholder in exchange for property (which includes money) it is a redemption.
The facts of this case establish that plaintiff's redemption of stock (by United) is in § 302(b)(1) language a redemption "not essentially equivalent to a dividend." As a consequence plaintiff is not excluded from § 302(a) capital gain treatment, assuming (as discussed below) plaintiff meets other statutory requirements for capital asset as opposed to non-capital asset treatment. By § 302(b)(5) meeting this test suffices though other tests under (b)(2), (3) and (4) are not met. By § 302(d), § 301 applies only if § 302(a) does not apply, but here it does apply because of § 302(b)(1).
The test for what is "essentially equivalent to a dividend" (for purposes of § 302(b)(1)) was discussed at length in Himmel v. Com'r, 338 F.2d 815 (2d Cir. 1964). The court stated a twofold test, at 817:
The hallmarks of a dividend, then, are pro rata distribution of earnings and profits and no change in basic shareholder relationships.
It has already been noted that the redemption shifted plaintiff's portion of the outstanding stock only from 18.0% to 16.1%, a mere 1.9% shift which is not "substantially disproportionate" § 302(b)(2), and a non-significant change in basic shareholder relationships under the facts of this case. However, the Bylaws effectively preclude meeting the first part of the twofold test: pro rata distribution.
A pro rata distribution would occur only if every stockholder had X number of shares redeemed for every share of preferred stock held. This cannot be.
Section 14 of Article 7 of the By-laws requires that "capital advances shall be retired in the order in which they have been received." All or the same proportion of all shares issued in a single year must be redeemed together.
Under Section 14, the only way a distribution could be pro rata across the class of stock is if every stockholder received the same number of shares in each year of issue.
To receive the same number of shares in each year of issue, under Section 10 of Article 7 of the By-laws, each shareholder must do...
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