Haft Trust v. C. I. R., No. 74--1302

• Citation: 510 F.2d 43
• Decision Date: 31 January 1975
• Docket Number: No. 74--1302
• Parties: 75-1 USTC P 9209 Robin HAFT TRUST et al., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (1st Circuit)

Page 43

510 F.2d 43

75-1 USTC P 9209

Robin HAFT TRUST et al., Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 74--1302.

United States Court of Appeals First Circuit.

Argued Dec. 2, 1974.

Decided Jan. 31, 1975.

Lewis H. Weinstein, Boston, Mass., with whom Norman H. Wolfe, Washington, D.C., Louis P. Georgantas, and Foley, Hoag & Eliot, Boston, Mass., were on brief for petitioners-appellants.

Carolyn R. Just, Atty., Tax Div., Dept. of Justice, with whom Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews and Leonard J. Henzke, Jr., Attys., Tax Div., Dept. of Justice, Washington, D.C., were on brief, for respondent-appellee.

Before COFFIN, Chief Judge, McENTEE and CAMPBELL, Circuit Judges.

McENTEE, Circuit Judge.

In their federal income tax returns for the year 1967 the taxpayer trusts reported gains from the redemption of certain stock they owned as longterm capital gains. The Commissioner determined that the gains were ordinary income and asserted deficiencies of $17,445.49 for each trust. The Tax Court found for the Commissioner and the taxpayers appeal. The issue before us is the relevance, after United States v. Davis, 397 U.S. 301, 90 S.Ct. 1041, 25 L.Ed.2d 323 (1970), of family hostility in mitigation of the constructive ownership rules of Code section 318 in determining dividend equivalence under section 302(b)(1). ¹

On October 28, 1956, Marcia Foster married Burt Haft. Two children were born of this marriage, and Burt Haft adopted his wife's two children by her deceased previous husband. After the marriage Marcia's father, Joseph C. Foster, loaned $200,000 to the Haft-Gaines Company, of which Burt Haft was an officer and stockholder, and purchased 100,000 shares of the company's common stock. In January of 1962 he created the four identical taxpayer trusts, one for each grandchild, and transferred 25,000 shares of Haft-Gaines stock to each without consideration.

In November 1966 Marcia Haft commenced divorce proceedings against Burt Haft, and each made serious and bitter charges and countercharges against the other. To separate the parties' financial interests and to provide for their future relationship, there were negotiations in which both were represented by lawyers or accountants, and Joseph Foster, Burt Haft, and Burt's brother-in-law Jack Gaines also participated at times. Disputes characterized the discussions that led to the property settlement between Mr. and Mrs. Haft. When Mrs. Haft initiated the divorce, Burt Haft moved his residence from the house they had been occupying in Bay Harbor, Miami Beach, Florida, and had no contact with the children until six or seven months later, although he had obtained extensive visitation rights and was still residing in Florida during this period. Sometime after her divorce and before 1970, Marcia Haft remarried. Thereafter, she and her new husband moved to New York, taking the children with them. After the divorce was granted on June 26, 1967, Burt Haft was indifferent to the children; he did not see them at all from the time of the divorce until 1971. After 1971 they visited him in Florida; he saw them at Christmas of 1972. After November 1966 he did not pay support for the children until a court decree ordered him to do so, and he ceased paying support entirely in the middle of 1970, although his income during the period was quite high.

While the divorce proceedings were taking place, Mr. Foster and the trusts terminated their financial involvement in the corporation. There were negotiations concerning retirement of the debt owed by the corporation to Mr. Foster, and it was finally paid in March 1967. There were also negotiations respecting the termination of the trusts' stock interests. The corporation originally offered $183,000 for all the trusts' shares, but in a subsequent meeting the offer was raised. On June 17, 1967, it was agreed that the trusts' shares would be redeemed for $250,000 plus 6 percent interest, if the corporation chose to pay the purchase price in installments over a period of years, and $200,000 plus 6 percent interest, if the entire purchase price was paid on or before February 1, 1968. The corporation agreed that while this obligation was outstanding, it would not pay dividends, would not pay compensation in excess of $200,000 to its shareholder-employees, would not recapitalize, and would not dispose of most or all of its assets. The corporation elected to complete payment for the stock in 1967.

Immediately before the redemption of the stock on June 17, 1967, the stock of the corporation was owned as follows:

                                                              Shares
                Burt Haft ................................... 100,000
                Richard Haft (Burt's brother) ............... 100,000
                Jack Gaines ................................. 100,000
                Abraham Haft Trust for the benefit of Burt
                  Haft, Richard Haft, and Norma Gaines
                  (Burt's sister) ........................... 100,000
                Robin Haft Trust ............................. 25,000
                Wendy Laura Haft Trust ....................... 25,000
                Lisa Ann Haft Trust .......................... 25,000
                Daniel Foster Haft Trust ..................... 25,000
                                                              -------
                       Total ................................ 500,000
                

After the redemption of the stock of the last four trusts listed above, only 400,000 shares of the stock of the corporation were outstanding.

In form a redemption is a sale of stock like any other sale of stock and would as such be entitled to capital gains treatment like other such sales. However, redemption could be used as a device to bail out dividends at capital gains rates if a corporation could redeem its shares proportionately and thus pay cash to the shareholders just as a dividend would without the shift in control that characterizes true sale transactions. Moreover, even a redemption disproportionate on its face may not in reality result in any shift in control if the shareholders comprise an economic unit like a family, in which the usual community of interest makes insignificant the precise location of title to shares. The Code handles these problems by treating redemptions as sales only if they meet one of the tests of section 302(b), subsection (1) of which provides for such treatment provided the distribution is 'not essentially equivalent to a dividend.' Dividend equivalence under this test results whenever the practical result of the transaction is to distribute accumulated earnings essentially pro rata while leaving ownership basically unchanged. Bradbury v. Commissioner, 298 F.2d 111, 115--116 (1st Cir. 1962). Section 302(c)(1) calls for the application under these tests of the complex rules of section 318 attributing constructive ownership between family members and between entities and their beneficiaries.

Although the taxpayers here were divested of all their shares in the Haft- Gaines Company, the redemption actually resulted in a slight increase in their proportional interests under the attribution rules from 31 2/3% to 33 1/3%, indicating no significant shift in control under the principle of Bradbury, supra. ² However, in Estate of Squier v. Commissioner, 35 T.C. 950 (1961), the Tax Court embraced the principle that family discord could belie the community-of-interest rationale of the attribution rules and was thus a relevant circumstance in determining dividend equivalency under (b)(1);

'Even after applying the attribution rules . . . the record herein reveals a sharp cleavage between the executor and members of the Squier family, and in spite of the attribution rules as to stock 'ownership' the redemptions herein in fact resulted in a crucial reduction of the estate's control. Accordingly, notwithstanding the attribution rules, the redemptions in this case did result in a substantial dislocation of relative stockholding in the corporation and also in fact brought about a significant change in control.' 35 T.C. at 956--957.

We endorsed this principle in dictum the following year in Bradbury v. Commissioner, supra. ³ Taxpayers argued its applicability in the present case, but the court below took the view that Squier was overruled sub silentio by the Supreme Court's decision in United States v. Davis, 397 U.S. 301, 90 S.Ct. 1041, 25 L.Ed.2d 323 (1970). Davis involved no claim of family hostility. Nevertheless, although he has not withdrawn his acquiescence in Squier, the Commissioner argues against the leading scholarly commentators ⁴ that Davis' interpretation of § 302(b)(1) necessarily establishes the irrelevance of family discord. We do not so read that case. In Davis, taxpayer owned 25 percent of the common stock of the redeeming corporation, and his wife, son, and daughter owned the remaining 75 percent which was attributed to him under section 318. Taxpayer also owned all the outstanding preferred, which he had purchased soon after the corporation was organized in 1945 so that it could meet the capitalization prerequisites for a Reconstruction Finance Corporation loan. It was understood that the corporation would redeem the preferred stock when the loan was repaid. In 1963 the corporation redeemed its preferred in accordance with this understanding, and taxpayer treated his gain as not essentially equivalent to a dividend under § 302(b)(1). The Commissioner maintained that taxpayer was to be regarded as the sole shareholder because of the attribution rules, and that all distributions to such a shareholder were proportional, hence dividends, regardless of any legitimate business purpose.

In arguing before the Supreme Court taxpayer sought to avoid this result by contending on the basis of minor discrepancies in wording among the subsections of section 302(b) that the attribution principle was irrelevant in the application of the 'not essentially equivalent to a dividend' test of § 302(b) (1). The Court gave this argument short shrift. But in holding...