Bradbury v. CIR, 5871.

• Decision Date: 15 January 1962
• Docket Number: No. 5871.,5871.
• Citation: 298 F.2d 111
• Parties: Eva D. BRADBURY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — First Circuit

298 F.2d 111 (1962)

Eva D. BRADBURY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 5871.

United States Court of Appeals First Circuit.

Heard November 6, 1961.

Decided January 15, 1962.

Raymond S. Oakes, Portland, Me., with whom Oakes & Oakes, Portland, Me., was on brief, for petitioner.

George F. Lynch, Atty., Dept. of Justice, Washington, D. C., with whom Louis F. Oberdorfer, Asst. Atty. Gen., and Lee A. Jackson and A. F. Prescott, Attys., Dept. of Justice, Washington, D. C., were on brief, for respondent.

Before WOODBURY, Chief Judge, and HARTIGAN and ALDRICH, Circuit Judges.

HARTIGAN, Circuit Judge.

This is a petition for review of a decision of the Tax Court of the United States which entered judgment sustaining a determination by the Commissioner of Internal Revenue of a deficiency in the income tax due from the petitioner for the taxable year 1956 in the amount of $7,518.89.

This case raises the question of whether the cancellation of petitioner's indebtedness to a corporation and an additional credit to her account, upon the redemption of forty-four shares of stock which she held in the corporation were a distribution essentially equivalent to a dividend within the meaning of Section 302(b) (1) of the Internal Revenue Code of 1954, 26 U.S.C.A. § 302(b) (1).

In 1938 the petitioner, Mrs. Eva D. Bradbury organized the L. L. Bradbury Corporation for the purpose of carrying on the lumber manufacturing business which had been formerly conducted by her deceased husband. At incorporation all of the capital stock, which consisted of 300 shares of common stock valued at $100,599.54, was issued to her, except for two qualifying shares which were issued to nominees of petitioner. Commencing in 1947, petitioner transferred shares of this stock to her daughter, Olive Landry, and to her son-in-law, Carl A. Landry. On July 2, 1956, the date on which the instant redemption took place, petitioner held 177 shares, her daughter 86 shares and her son-in-law 25 shares, aggregating the 288 shares of the L. L. Bradbury Corporation then outstanding.¹

From July 30, 1938 through July, 1956 the Bradbury Corporation continually maintained an "open account" in petitioner's name on its books. Petitioner utilized this drawing account to pay her personal expenses. Whenever petitioner was in need of cash, she would make a request of the corporation for the amount she needed. It would be given to her and her account debited. Occasionally petitioner would request the corporation to make direct payments to third persons in her behalf.

From its organization through the year 1956 petitioner was treasurer of the corporation and her account was credited with the amount of her salary. During the taxable years 1945, 1946, 1949 and 1950 through 1952 the Bradbury Corporation declared dividends and credited the amounts of these dividends to petitioner's account. No dividends were declared or paid from the taxable year 1953 to the taxable year 1956, inclusive. From October 1939 until July 2, 1956, petitioner's account showed a continuous debit balance.

On July 2, 1956, petitioner's account indicated that she was indebted to the corporation in the amount of $21,068.94. On that day petitioner transferred 44 shares of her stock to Bradbury Corporation, and the corporation credited her account in the amount of $22,489.28, resulting in a credit balance therein of $1,420.34. Following this transfer, the outstanding stock of the corporation numbered 244 shares, of which taxpayer held 133 shares, Olive Landry 86 shares and Carl A. Landry 25 shares. The 44 shares of petitioner's stock which were redeemed have been held by the corporation as treasury stock. The corporation has continued to actively engage in the lumber business since the transfer.

The facts giving rise to the instant transaction were substantially as follows. Bradbury Corporation was engaged principally in the manufacture of long lumber at its saw mill in York County, Maine. As an adjunct of its main operation it also manufactured box shocks which were made into boxes in a separate building called the "box mill." By 1956 the corporation's saw mill, which had originally been built in 1917 or 1918, had become so obsolete that the corporation could no longer compete effectively with its competitors. Faced with the alternatives of modernizing its saw mill operations or perhaps being forced out of business, the corporation decided to build a new mill. Having made this decision the officers of the corporation next explored the possibility of obtaining financing to accomplish the construction. In February 1956, petitioner, her daughter and son-in-law approached a certain Mr. Ireland — an official of the Canal National Bank — to discuss whether the bank would finance construction of the corporation's proposed new mill. In the past the corporation had frequently borrowed money from this bank to cover operating expenses in connection with particular consignments of lumber.² However, on this occasion, before reaching a decision on whether the bank would lend money in connection with the proposed construction, the bank official requested copies of the corporation's financial statement for the preceding two or three years and also a statement for the current quarter.

In June 1956, in a conference at the bank, petitioner, together with Olive and Carl Landry, were informed that the bank "did not like" the account due from petitioner which as of December 31, 1955 amounted to $20,269.71. The record indicates that Mr. Ireland informed petitioner and the Landrys that the petitioner's account should be "cleaned up some way." The record also shows that the bank official did not indicate specifically how the "cleaning up" should be accomplished.

Thereafter, petitioner, her daughter and son-in-law discussed the matter among themselves and apparently at Mrs. Bradbury's own suggestion, it was decided that she would transfer 44 shares of her stock to the corporation and that her account would be credited with $22,489.28. Once this transfer was accomplished a new financial statement was taken to the bank and, in due course, the corporation received a loan from the bank for use in constructing the saw mill. The loan, long term in nature, was approximately $12,000 in amount and called for repayment to be completed in August, 1961.

On her 1956 income tax return, petitioner reported the amount of $22,489.28 as a distribution in full payment in exchange for the redemption of 44 shares of Bradbury Corporation's stock on which she reported a long-term capital gain of $7,734.76. The Commissioner in his notice of deficiency determined that taxpayer received a taxable dividend in the amount of $22,489.28 in July, 1956 upon the redemption of the 44 shares of common stock of the corporation and increased the net income as disclosed by her return by this amount less the amount of $3,867.38 reported by her as the long-term capital gain. The Tax Court sustained the Commissioner's determination and petitioner now seeks a review of the decision of the Tax Court.

The present record poses the vexing question of whether a distribution by a corporation in exchange for a portion of its outstanding stock is to be considered as giving rise to dividend income or capital gain to its stockholders. When a corporation acquires its own stock from a shareholder the event may bear the indicia of a true "sale" — equivalent to an arms length transaction with a third person — or it may in terms of its economic realities more closely resemble the distribution of a dvidend. See Bittker, Federal Income Taxation of Corporations and Shareholders (1959), 208-209. Those transactions which more closely resemble sales are accorded capital gains treatment while those partaking of the essential attribute of a dividend — however styled — are taxable at ordinary income rates. Where the shareholder transfers his stock back to the corporation incident to a corporate distribution to him, the ultimate question is whether the surrender of the shares is an economically meaningful gesture or a sterile exercise in formalism. The mere fact that shares are turned in to the corporation incident to the distribution is a wholly neutral circumstance in assaying the tax incidence of the transaction. Tax wise the transfer will derive its significance and sustenance from the totality of its surrounding circumstances from which it cannot be severed. In sum, if a distribution is in the nature of a dividend it will be so treated. Commissioner of Internal Revenue v. Van Vorst, 59 F.2d 677, 681 (9 Cir., 1932). Needless to say, formal declaration of a dividend is not required. "The principle that substance and not form should control in the application of tax laws * * * is pertinent in this case. Tax laws deal with realities and look at the entire transaction. * * *" Helvering v. Gordon, 87 F.2d 663, 666 (8 Cir., 1937).

In the Internal Revenue Code of 1954 Congress dealt with the question of corporate redemptions³ in Section 302. Under the statutory scheme, property received in redemption of stock is taxed as capital gain or loss under Section 302(a) if the redemption qualifies as one of four types of transactions set forth in Section 302(b). The four types are: (1) a redemption which "is not essentially equivalent to a dividend;" (2) a distribution which is "substantially disproportionate with respect to the shareholder;" (3) a distribution which is "in complete redemption of all of the stock of the corporation owned by the shareholder;" (4) a distribution in redemption of stock issued by a railroad corporation incident to a reorganization plan under Section 77 of the Bankruptcy Act, 11 U.S.C.A. § 205. Thereafter, under Section 302(d) any redemption⁴ which fails to qualify under one of the above-cited categories will be treated as a distribution of property under Section 301 — the codal provision relating to dividends and distributions which...