Opinion ID: 334653
Heading Depth: 1
Heading Rank: 3

Heading: the constructive dividend

Text: 31 The second step in this three-prong transaction involved a transfer of $42,513.54 from Kuper Volkswagen to what was for only a single day that company's wholly owned subsidiary, Enterprise. At trial, the Commissioner sought to characterize the transfer as a constructive dividend of $21,256.77 13 to James and Charles. In support of his position, the Commissioner argued that if the February 28-March 1 transactions were in reality an exchange of stock between George Kuper and petitioners, then it necessarily follows that the $42,513.54 constituted, at the shareholder level, a part of the purchase price for George's Volkswagen stock. Therefore, the petitioners received a direct economic benefit from the transfer. Moreover, this economic benefit was taxpayers' primary purpose for structuring the transaction as they did. As such, dividend treatment is proper under the Fifth Circuit's decision in Sammons v. Commissioner of Internal Revenue, 5 Cir.1972, 472 F.2d 449, where Judge Clark wrote: 32 In every case, the transfer must be measured by an objective test (the distribution test): did the transfer cause funds or other property to leave the control of the transferor corporation and did it allow the stockholder to exercise control over such funds or property either directly or indirectly through some instrumentality other than the transferor corporation. If this first assay is satisfied by a transfer of funds from one corporation to another rather than by a transfer to the controlling shareholder, a second, subjective test of purpose must also be satisfied before dividend characterization results. Though a search for intent or purpose is not ordinarily prerequisite to discovery of a dividend, such a subjective test must necessarily be utilized to differentiate between the normal business transactions of related corporations and those transactions designed primarily to benefit the stockowner. Id. at 451. 33 The Tax Court, although recognizing that dividend denomination does not depend on a formal corporate declaration 14 or a distribution directly to shareholders, 15 rejected the Commissioner's arguments. 61 T.C. at 632. Viewing the transfer independently of the other steps, Judge Fay found that it was primarily motivated by a valid corporate business reason, i. e. the elimination of managerial friction, and that any shareholder benefit was incidental to this primary corporate purpose. Id. at 632-33. Thus, the Tax Court reasoned that under the primary benefit test of Sammons, supra; W. B. Rushing, 52 T.C. 888 (1969), aff'd on other grounds, Rushing v. Commissioner of Internal Revenue, 5 Cir. 1971, 441 F.2d 593; and Walter K. Dean, 57 T.C. 32 (1971), the Government failed in its dividend contention. For the reasons stated below, we disagree with the Tax Court and reverse its decision as to the dividend issue. 34
35 Our review of the case law in this area reveals that although Sammons speaks of the subjective intent to primarily benefit the shareholder, the search for this underlying purpose usually involves the objective criterion of actual primary economic benefit to the shareholders as well. See, e. g., Rapid Electric Co., 61 T.C. 232 (1973). This objective facet of the Sammons' primary benefit test (which inevitably overlaps with the Sammons' objective distribution test, see Section III.B. infra.) is clearly observed in W. B. Rushing, supra; Commissioner of Internal Revenue v. Offutt, 4 Cir. 1964, 336 F.2d 483; and Walter K. Dean, supra, cases on which Sammons relies. As noted above, in the present case the Tax Court made findings as to both the primary economic purpose and the actual primary economic effect, see 61 T.C. at 632-33, and we shall examine both of these findings. 36 When viewed in the context of the overall transaction, we have little doubt but that petitioners' dealings were primarily intended to create and in fact did create a direct and primary economic benefit to the Kuper Volkswagen shareholders. Enterprise maintained its subsidiary status for a mere twenty-four hours. 16 During this time, the taxpayers caused Kuper Volkswagen to pay $42,513.54 to Enterprise with the knowledge that control of the latter company and therefore the money would be shifted the next day, all without expectation of repayment to Kuper Volkswagen. 17 Thus, the transitory parent-subsidiary relationship served merely as a conduit for the movement of funds the effect and purpose of which was to lessen the consideration which would have passed from James and Charles to George had there been a simple exchange of stock. The evidence, including a Board of Director's resolution and a stipulation of fact as well as taxpayer's brief makes clear that taxpayers shifted the $42,513.54 in order to equalize the values of Enterprise at the fraction of Volkswagen's value which would make the subsequent division of Enterprise and Kuper Volkswagen ownership a fair one. The obvious purpose of this equalization was to permit what in substance was a stock swap among shareholders without the need for the shareholders to exchange money directly or to incur taxes at petitioners' level. This benefit to the shareholders with its concomitant shareholder tax savings cannot be deemed indirect, incidental or ancillary. 18 37 Because of the deference accorded to the Tax Court pursuant to the clearly erroneous rule, see Sammons, 472 F.2d at 452; Chared Corp., 446 F.2d at 746, we are usually reluctant to substitute our own findings as to primary purpose and benefit for those of the Tax Court. However, in this instance, we are reinforced in our view by Judge Fay's earlier determination, discussed in Section II, supra, and our own conclusion that the other steps in this integrated transaction had no valid business purpose and that their only conceivable purpose was the avoidance of tax consequences to petitioners. 61 T.C. 630. If the larger purpose of separating out interests in order to obviate management quarrels could not justify the first and third steps in this transaction, it certainly cannot legitimize this inextricably related middle step which, unlike the Tax Court, we refuse to consider apart from the remainder of the taxpayers' actions. 38 We do not hereby contest the Tax Court's factual finding that the $42,513.54 transfer (not to mention the other steps) facilitated a successful separation of the Kuper brothers' interests in Kuper Volkswagen a primary corporate goal. However, it is not the ultimate motivating factor which is in question but rather the intent behind the specific route by which the larger purpose was accomplished. See United States v. Ingalls, 5 Cir. 1968, 399 F.2d 143, 146. The trial court explicitly rejected the broader goal of eliminating managerial friction as a justification for treating the related steps of a stock contribution and purported redemption separately and characterizing them on an isolated basis. Similarly, that broader purpose cannot support discrete analysis of the cash transfer and thereby avoid our conclusion that when seen as a part of a taxpayer level exchange of stock, the $42,513.54 must be regarded as having been intended to benefit as well as having actually benefitted, directly and primarily, the Kuper Volkswagen shareholders.
39 Because the distribution of money away from the control of the transferor corporation and into shareholder control usually results in a direct economic benefit to the shareholder, the Sammons net distribution test, see Sammons, 472 F.2d at 451, 453-54, is closely related to the question of actual direct economic benefit which we have just discussed. In fact, neither party here discussed the distribution test, nor did the Tax Court, although everyone argued about the problem of actual economic benefit. However, we think that in the light of our conclusions in Sections II and III.A., supra, it suffices to say that when the present transactions are seen as a taxable shareholder exchange of stock, it is unmistakable that a net distribution of funds from Kuper Volkswagen has occurred and that the transferred funds came within the direct control of the Kuper Volkswagen shareholders who used them for their own benefit as shareholders. Thus, under Sammons, dividend treatment is proper, and to this extent the Tax Court's decision is reversed.