Radnitz v. United States

• Decision Date: 17 October 1960
• Citation: 187 F. Supp. 952
• Parties: Samuel E. RADNITZ, Jr. and Hattie Radnitz, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of New York

187 F. Supp. 952

Samuel E. RADNITZ, Jr. and Hattie Radnitz, Plaintiffs, v. UNITED STATES of America, Defendant.

United States District Court S. D. New York.

October 17, 1960.

Krisel, Lessall & Dowling, New York City, Jacob Krisel, New York City, of counsel, for plaintiffs.

S. Hazard Gillespie, Jr., U. S. Atty., New York City, Gustave J. Soderberg, Jr., Asst. U. S. Atty., Cambridge, Mass., of counsel, for defendant.

LEVET, District Judge.

This is an action under Title 28 U.S. C.A. § 1346 to recover federal income taxes paid for the year 1955. Plaintiffs reported profits from the sale of corporate stock as capital gains and paid the tax on this basis. The Commissioner of Internal Revenue determined that under the circumstances the entire amount received by plaintiffs for their stock was taxable as ordinary income and thereupon issued a deficiency assessment, totaling some $12,722.76, which was paid under protest by plaintiffs. There are no material issues of fact. Both parties have moved for summary judgment pursuant to Rule 56 of the Federal Rules of Civil Procedure, 28 U.S.C.A.

The plaintiffs, husband and wife, filed a joint return of their income for the year 1955. Together they owned 72 shares of the Turner Hall Corporation (hereinafter designated as "New York Turner Hall"), a New York corporation, which had issued and outstanding some 240 shares of stock. New York Turner Hall itself owned all of the issued and outstanding stock of Tylon Products, Inc. (hereinafter designated as "Tylon"), another New York corporation. Plaintiffs also owned 15 shares of the New Jersey Turner Hall Corporation (hereinafter designated as "New Jersey Turner Hall"), a New Jersey corporation, which had outstanding 100 shares of capital stock, 50 of which were also owned by New York Turner Hall. The individual shareholders of New Jersey Turner Hall together owned 90% of the stock of New York Turner Hall.

During the latter part of December, 1955, the plaintiffs, together with the other individual stockholders of New Jersey Turner Hall, sold all of their shares in this corporation to Tylon. As already noted, New York Turner Hall owned all of Tylon's stock, as well as the remaining 50% of the shares in New Jersey Turner Hall not individually owned.

A total of $75,000 was paid by Tylon for all 50 shares of New Jersey Turner Hall stock so transferred. Thus, each New Jersey Turner Hall stockholder received $1,500 per share. The plaintiffs, whose 15 shares had originally cost them $7,500, received $22,500, giving them a profit of some $15,000. There is no evidence to indicate that the consideration for plaintiffs' shares was furnished by anyone other than Tylon.

The issue is whether the amount of $22,500 received by plaintiffs in 1955 was taxable as dividend income, as determined by the Commissioner. The defendant maintains that the above stock transfers constituted redemptions under Section 304 of the Internal Revenue Code of 1954, 26 U.S.C.A. § 304, and that the entire amount received by plaintiffs was taxable as a dividend pursuant to the rules of Sections 301, 302, 304 and 316 of the Code, 26 U.S.C.A. §§ 301, 302, 304, 316. On the other hand, plaintiffs contend that since the transaction involved no distribution of Tylon's corporate assets or earnings and no reduction in its assets, the amount received by the plaintiffs could not be taxed as a dividend.

Section 304 of the Internal Revenue Code of 1954 provides in its relevant part as follows:

"304. Redemption through use of related corporations.

"(a) Treatment of certain stock purchases.—

"(1) Acquisition by related corporation (other than subsidiary).— For purposes of sections 302 and 303, if—

"(A) one or more persons are in control of each of two corporations, and

"(B) in return for property,¹ one of the corporations acquires stock in the other corporation from the person (or persons) so in control,

then * * * such property shall be treated as a distribution in redemption of the stock of the corporation acquiring such stock."

This section purports to prevent tax avoidance in transactions where persons controlling all or substantially all of the stock in two corporations, the so-called "class B affiliation," sell some of their stock in one corporation to the other. For purposes of Section 304, "control" is defined in Section 304(c) (1)² as denoting ownership of at least 50% of the total stock of a corporation, and encompasses subsidiaries of such a corporation in which it has at least 50% ownership.

Under Section 304(c) (1), therefore, persons controlling a corporation which itself controls another corporation are deemed to control the latter corporation as well. This rule is said to extend the "class B affiliation" case to purchases by a subsidiary corporation of stock in a corporation which is a "class B affiliate" of its parent. See Mertens, Federal Income Taxation (Code Commentary), Sec. 304(c):1, at 55 (1956).

Plaintiffs and the other individual stockholders who sold their shares in New Jersey Turner Hall controlled this corporation in view of their aggregate 50% stock ownership thereof. Due to their collective 90% ownership of New York Turner Hall stock, they also controlled that corporation and thus controlled its wholly-owned subsidiary, Tylon, as well. Since plaintiffs' transfer of their stock holdings was admittedly part of "substantially one transaction," whereby all individually-held shares in New Jersey Turner Hall were to be sold to Tylon, see deposition of Samuel E. Radnitz, Jr., pp. 7, 23, the entire stock transfer scheme should be treated as one for the purposes of Section 304. See Treas. Reg. § 1.304-2(b).

Section 304(c) (2) provides that the constructive ownership rules of Section 318(a) (2) (C), 26 U.S.C.A. § 318(a) (2) (C), are applicable to determine control under Section 304(c) (1), disregarding the 50% limitation contained therein.³ Consequently, persons owning any stock in a corporation are treated as owning stock owned directly or indirectly by or for that corporation, in the same proportion which the value of the stock such persons own bears to the value of all the stock in the corporation. See also Mertens, Federal Income Taxation (Code Commentary), Sec. 304(a) (1):1, at 52 (1956).

Applying the statutory directions of Section 304, quoted above, it is evident that the plaintiffs, with others, controlled two corporations. In return for cash payments, one of the corporations, Tylon (or, indirectly, New York Turner Hall), acquired stock in the other corporation, New Jersey Turner Hall, from these controlling persons. Section 304 provides that under these circumstances, the payment received for such stock shall be treated as a "distribution in redemption" of the stock of the acquiring corporation. Redemption, therefore, is here a condition precedent for ascertaining whether a distribution is essentially equivalent to a dividend.

The defendant argues that since the requisites of Section 304(a) (1) were satisfied in the instant case, the amount paid by Tylon for plaintiffs' shares was accordingly treated as a "distribution in redemption," which, if essentially equivalent to a dividend, became taxable under the redemption rules of Section 302. In other words, once the test of Section 304 is met, Section 302 and its related sections must be examined to determine whether the distribution in redemption is taxable as a dividend.

Plaintiffs contend, on the other hand, that no distribution in fact existed since the acquiring corporation, Tylon (or New York Turner Hall, which controls Tylon), did not acquire its own stock from its own stockholders in their capacities as such. Section 317(b) of the 1954 Code does provide, it is true, that "stock shall be treated as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property * * *." Yet, Section 304 expressly states that "for purposes of sections 302," amounts received for corporate acquisition of stock in another corporation shall, under certain circumstances, be regarded as a "distribution in redemption" of the stock of the acquiring corporation. For purposes of Section 302, therefore, this statute-imposed redemption is to be treated as if the corporation, Tylon, were in fact acquiring its own stock. In brief, a stock transaction between related companies, within the purview of Section 304, is termed a "distribution in redemption," subject to subsequent scrutiny under Section 302 to determine whether such distribution is a taxable dividend.

Plaintiffs would here reverse the pattern and hold that Section 304 comes into play only after a Section 302 situation exists. That is, once there has been a distribution essentially equivalent to a dividend under the rules of Sections 301 and 302, then, under Section 304, the use of related corporations to effectuate this distribution will not prevent application of dividend equivalency. If there is initially no distribution under Section 302, it is argued, then Section 304 is inapplicable.

Plaintiffs further aver that the payments received for their New Jersey Turner Hall stock cannot be treated as "distributions" under Sections 301 and 302 of the Code since the acquiring corporation, Tylon, in fact received valuable assets, viz., shares of stock, in exchange for the money expended, and its total assets were not thereby diminished. Consequently, they conclude, there could be no "distribution" under Section 304.

These arguments, however persuasive at first blush, would appear to run counter to the congressional purpose evinced by the statutory provisions and to the import of the Code.

Section 304 represented a further effort in the 1954 Code to seal possible breaches in the corporate tax structure regarding sales of stock among groups of controlled and related corporations.⁴ As the Senate Finance Committee Report stated:

"The effect of the operation of section 304 is to characterize as redemptions

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