Ballenger v. United States

• Citation: 301 F.2d 192
• Decision Date: 19 March 1962
• Docket Number: No. 8423.,8423.
• Parties: Charles P. BALLENGER, Jr., and Myrtle S. Ballenger, Appellants, v. UNITED STATES of America, Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (4th Circuit)

301 F.2d 192 (1962)

Charles P. BALLENGER, Jr., and Myrtle S. Ballenger, Appellants, v. UNITED STATES of America, Appellee.

No. 8423.

United States Court of Appeals Fourth Circuit.

Argued October 25, 1961.

Decided March 19, 1962.

C. Thomas Wyche, Greenville, S. C. (Wyche, Burgess & Wyche, Greenville, S. C., on the brief), for appellants.

Carolyn R. Just, Atty., Dept. of Justice (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson and Loring W. Post, Attys., Dept. of Justice, and Joseph E. Hines, U. S. Atty., on the brief), for appellee.

Before SOBELOFF, Chief Judge, and SOPER and BELL, Circuit Judges.

J. SPENCER BELL, Circuit Judge.

This is an appeal from a judgment of the District Court denying a refund of income taxes in the amount of $14,655.03 plus interest for the year 1954. The explanation given for the deficiency assessment was that the redemption of all of the outstanding preferred stock of the corporation, which was owned by the taxpayers, who are husband and wife, was essentially equivalent to a dividend and, was not, therefore, entitled to capital gains treatment under the provisions of § 302(b) (1) of the Internal Revenue Code of 1954.

A chronological statement of the pertinent facts is as follows: In 1949 the Ballenger Paving Company, a corporation, was organized to succeed a partnership of the same name and engaged in the same business because one of the partners had died intestate leaving a widow and minor child. The court having jurisdiction of the estate agreed to incorporation of the business as an alternative to liquidation. It was represented to the court that preferred stock would be issued to the estate and the widow and common stock to the remaining participants, but these plans were not carried out and the estate and the widow received both common and preferred stock, as did all parties concerned.

In the resulting corporate setup, taxpayers received 260 shares each of common and preferred, representing approximately 20% of the outstanding stock. The remaining 80% of the stock went to unrelated parties, including the estate and widow of the deceased partner.

On January 29, 1953, a resolution was adopted by the corporation calling for the liquidation of all of the stock both common and preferred held by parties other than taxpayers. These resolutions referred to the transaction as a partial liquidation. They made no reference to retirement of taxpayers' stock, either preferred or common.

By March 13, 1953, the retirement of all of the stock other than that held by taxpayers was accomplished by exchanging machinery and equipment owned by the corporation for the stock. Minutes of a meeting held on March 30, 1953, referred to the partial liquidation of the company as having been completed.

On August 20, 1954, taxpayers, being all of the stockholders and directors of the corporation, caused resolutions to be passed calling for the retirement of all of the outstanding preferred stock in accordance with the terms of the certificates. The only reason for this action expressed in the minutes was the desire to eliminate the 5% annual dividend called for by the terms of the preferred stock.

On September 11, 1954, the taxpayers received $27,300.00 from the corporation, that being the call price of 260 shares of preferred in accordance with the terms of the stock certificates.

There is no contention that taxpayers intended to liquidate the corporation or even contract the company's operations; on the contrary, the operations were steadily expanding. Corporate earned surplus on the date of redemption was far in excess of $27,300.00. Proportion of stock ownership and voting control of the corporation were not changed by the retirement. Dividends had never been declared or paid on the common stock during the history of the corporation.

Upon the foregoing facts the District Court found that the stock redemption was essentially equivalent to the distribution of a taxable dividend under § 301 of the 1954 Act and, therefore, treated same as gross income to the taxpayers.

The taxpayers argue that the preferred stock which was being retired was originally issued for a valid business purpose: to prevent the liquidation of the business upon the death of one of its partners. They contend that when the stock of all the other stockholders was redeemed in 1953 the reasons for issuing preferred stock ceased to exist and this in itself constituted a valid business reason for redeeming their preferred stock. Indeed they say that the 1954 redemption of their stock was but the final step of a plan to liquidate all the preferred stock begun with the corporate resolutions of January 1953.

The Government denies that a valid corporate business purpose existed for redemption of taxpayers' stock at the time in question, but insists that even had a valid business purpose existed it would not in and of itself be sufficient to remove the transaction from the category of a dividend. It contends that the statute defines a dividend as any distribution by a corporation to stockholders paid out of accumulated or current earnings regardless of whether or not it was designated as such. The only exceptions recognized (with which we are here concerned) and thus given preferential treatment as capital gains under § 302 (b) of the 1954 Code are: (1) redemptions not essentially equivalent to a dividend, (2) redemptions that are substantially disproportionate, and (3) a complete redemption of all of a shareholder's stock.

For the purposes of the case, the pertinent parts of the 1954 Code became effective on June 22, 1954. INTERNAL REVENUE CODE OF 1954, § 391. Before attempting to apply the law to the facts of this case, let us examine some of the differences between the 1939 Code and the 1954 Code.

The 1954 Code substantially recast the law in this field. The distribution and reorganization provisions of the 1939 Code were sorted out and then rearranged into separate parts of subchapter C of Chapter 1 of subtitle A of the 1954 Code. Part I of subchapter C (26 U.S.C.A. §§ 301-318) contains rules for testing distributions by corporations other than liquidating distributions. Part II of subchapter C (26 U.S.C.A. §§ 331-346) covers liquidating distributions. Part III of subchapter C (26 U.S.C.A. §§ 351-367) covers corporate organizations and reorganizations with which we are not concerned in this case. In making the breakdown between Parts I and II of subchapter C an attempt was made to separate into their significant elements two general categories of cases dealing with corporate distributions which had been previously lumped together and treated as partial liquidations under § 115(a) and § 115(g) (1) of the 1939 Code. Thus under the 1954 Code, the category of cases wherein a distinction was drawn between stock redemptions which were to be given capital gains treatment rather than dividend treatment because they met certain tests when viewed from the standpoint of the stockholder's actions or motives are treated in Part I (26 U.S.C.A. §§ 301-318). On the other hand, the category of cases wherein a distinction was drawn between stock redemptions which were to be given capital gains treatment rather than dividend treatment because they met certain tests when viewed from the standpoint of the corporation's actions or motives are treated under Part II (26 U.S. C.A. §§ 331-346). In each category specific tests are provided which if met would entitle the distribution to capital gains treatment, but in each category there is also included a general negative test, e. g., that the distribution be "not essentially equivalent to a dividend" which if not met will deny the distribution capital gains treatment. See § 302(b) (1) and § 346(a) (2). The success of the effort to clarify the law in this area would have been unquestioned had not this vague negative test been included in the 1954 Code, thus re-injecting the confusion theretofore developed by the case law which has attempted to interpret the phrase "not essentially equivalent to a dividend".

When we attempt to apply the 1954 Code to a particular case, we must first determine whether or not the transaction meets the tests laid down in Part II, i. e., does it constitute a "partial liquidation" as therein defined? If not, we then turn to the specific tests set forth in subsections (b) (2), (b) (3) and (b) (4) of § 302. If none of these specific tests apply then we must determine whether the distribution is "not essentially equivalent to a dividend" under subsection (b) (1) of § 302. If it is not essentially equivalent to a dividend, it is entitled to capital gains treatment, no matter that it fails all of the more specific tests set forth in the Code.

Turning now to the instant case, the facts do not bring it within the provisions of Part II of the 1954 Act, §§ 331-346, nor indeed does the taxpayer so contend. By § 331, capital gains treatment is accorded to property received by the taxpayer from a corporation in partial liquidation. The definition of a partial liquidation is found in § 346. Subsection (a) (2), the only part of § 346 relevant here, provides that a distribution of corporate property is treated as a partial liquidation if "the distribution is not essentially equivalent to a dividend, is in redemption of a part of the stock of the corporation pursuant to a plan, and occurs within the taxable year in which the plan is adopted or within the succeeding taxable year". The legislative history,¹ the Treasury Regulations,² and the applicable cases³ indicate that a primary factor to be considered in the definition of a partial liquidation, although not the sole factor, is whether there has been a contraction in the business of the corporation.⁴ This test is not met in the present case, for there is no evidence of any lessening in the business being carried on by Ballenger Paving Company as a result of the redemption of the taxpayer's preferred stock. Indeed, the business...