Opinion ID: 757876
Heading Depth: 3
Heading Rank: 1

Heading: Return of Capital

Text: 10 On the morning of the last day of the government's case, one day before the trial court submitted the case to the jury, Bok presented the court with several additional requests to charge. One of them concerned the treatment for tax purposes of money withdrawn by a shareholder from a corporation. Through that proposed charge, Bok sought to characterize the money he received from Abacus for his condominium and his municipal bonds as a nontaxable return of capital that he had invested in the corporation rather than as a taxable dividend. The proposed charge read as follows: Return of Capital Non-Income Transaction 11 If a shareholder in a corporation withdraws his capital from that corporation, either all or part of that withdrawal is not income to the shareholder, and need not be reflected on that shareholder's personal income tax return. The same treatment occurs if the shareholder directs the corporation to pay to a third party for his benefit all or part of his capital contribution. 12 Defendant's Additional Requests to Charge at 2. The government opposed the use of the proposed charge, arguing both that it was not legally correct as written and that there was no basis in fact for its inclusion in the charge as a whole. 13 After entertaining arguments from both sides, the trial court decided against including Bok's proposed charge as written. The trial judge did invite Bok to work with the government to craft a more correct statement of the law, but the two sides evidently never reached agreement on an instruction. The trial judge went on to say that, in keeping with his obligation to instruct the jury correctly on the law, he had included a charge about a corporate distribution and how that can be income. Trial Transcript at 963. Ultimately the relevant portion of the charge read as follows: 14 Gains or profits and income derived from any source whatever are included in gross income for the purpose of taxation of income. This includes both lawful and unlawful gains. 15 In order to prove that the defendant received substantial additional income omitted from his tax return, the government has introduced evidence that the defendant was the sole shareholder, or owner, of Abacus Construction Corp., a corporation, and received certain funds or assets from the corporation for the purchase of an apartment and a bond. 16 If you find that the defendant obtained such funds, or assets, or other property from Abacus Construction Corp., then you should proceed to determine whether this was income to the defendant. 17 In this connection, the question for you to determine is whether the defendant had control over the funds, or assets, or other property from that corporation, took it as his own and treated it as his own, so that as a practical matter he derived economic value from the funds, or assets, or other property received. If you find this to be the case, then the funds, or assets, or property received by the defendant would be income; if you do not find this to be the case, then the funds or assets or other property obtained by the defendant would not be income to the defendant. 18 Trial Transcript at 1126-27. 19 We have long recognized that under certain circumstances monies lawfully withdrawn from a corporation by one of its shareholders may constitute a nontaxable return of capital. See United States v. D'Agostino, 145 F.3d 69, 72 (2d Cir.1998); DiZenzo v. Commissioner, 348 F.2d 122, 125 (2d Cir.1965). A central condition for the application of the return of capital theory--which we have also called the no earnings and profits, no income rule--is that the corporation must not have earned a profit for the year in which the withdrawal was made. See D'Agostino, 145 F.3d at 72. Under this theory, if a shareholder has invested capital in a corporation and the corporation has not earned a profit for the year at issue, any monies the shareholder removes from the corporation (up to the amount of invested capital) constitute only a return of the shareholder's basis, not dividend income. 20 The return of capital theory derives from the Internal Revenue Code itself, which defines the term dividend to mean any distribution of property made by a corporation to its shareholders ... out of its earnings and profits of the taxable year, ... without regard to the amount of the earnings and profits at the time the distribution was made. 26 U.S.C. § 316(a)(2) (1994) (emphasis added). The Code further provides that [t]hat portion of the [corporate] distribution [of property to its shareholders] which is not a dividend shall be applied against and reduce the adjusted basis of the stock. 26 U.S.C. § 301(c)(2) (1994). The natural implication of the two provisions read together is that in the absence of earnings or profits, a shareholder may treat any distribution up to the value of capital invested in the corporation--that is, the taxpayer's basis--as a return of that capital. Both the Tax Court and the Tax Litigation Service of the IRS have explicitly adopted this approach in the civil enforcement context. See Truesdell v. Commissioner, 89 T.C. 1280, 1294-95, 1987 WL 258105 (1987); Truesdell, action on decision, 1988-025, 1988 AOD Lexis 22 (Sept. 12, 1988). 21 We have made clear that the return of capital theory applies equally in both criminal and civil cases, assuming that the diversion itself was not unlawful. 1 See D'Agostino, 145 F.3d at 72-73; see also United States v. Leonard, 524 F.2d 1076, 1083 (2d Cir.1975) (Friendly, J.) (recognizing the return of capital theory in a criminal tax prosecution but holding that the defendant failed to meet the burden of going forward as to the corporation's lack of earnings or profits), cert. denied, 425 U.S. 958, 96 S.Ct. 1737, 48 L.Ed.2d 202 (1976). In D'Agostino, we explicitly rejected the prevailing rule in several of our sister Circuits. See 145 F.3d at 72-73. These require only that the government prove that the taxpayer had actual command over the funds at issue in a criminal tax evasion case and do not require a showing that earnings and profits existed in a year in which the distribution was made. See United States v. Williams, 875 F.2d 846, 850-52 (11th Cir.1989); United States v. Goldberg, 330 F.2d 30, 38 (3d Cir.), cert. denied, 377 U.S. 953, 84 S.Ct. 1630, 12 L.Ed.2d 497 (1964); Davis v. United States, 226 F.2d 331, 335-36 (6th Cir.1955), cert. denied, 350 U.S. 965, 76 S.Ct. 432, 100 L.Ed. 838 (1956). 22 Similarly, in return of capital cases, a taxpayer's intent is not determinative in defining the taxpayer's conduct. That is, the taxpayer or the corporation need not have described the distribution at issue as a dividend or a return of capital at the time it was made; rather, the realities of the transaction--including the amount of the shareholder's basis and the corporation's earnings or profits, as well as the amount of the distribution--govern its characterization for tax purposes. See D'Agostino, 145 F.3d at 72-73. In this way, the court in D'Agostino applied the return of capital theory even though it had little doubt the D'Agostinos acted with bad intentions when Mrs. D'Agostino surreptitiously diverted up to $4,000 each week in large bills from the couple's solely-owned businesses to her kitchen drawer. 2 Id. at 70, 73. 23 The fact that the return of capital theory applies in this Circuit does not, however, end our inquiry. We must also determine whether Bok established an adequate basis in the record for the proposed charge. The legal standard is generous: Generally a criminal defendant is entitled to instructions relating to his theory of defense, for which there is some foundation in the proof, no matter how tenuous that defense may appear to the trial court. United States v. Dove, 916 F.2d 41, 47 (2d Cir.1990), quoted in United States v. Workman, 80 F.3d 688, 702 (2d Cir.), cert. denied, --- U.S. ----, 117 S.Ct. 319, 136 L.Ed.2d 233 (1996). On appeal, however, [a] conviction will not be overturned for refusal to give a requested charge ... unless that instruction ... represents a theory of defense with basis in the record that would lead to acquittal. United States v. Allen, 127 F.3d 260, 265 (2d Cir.1997) (quoting United States v. Vasquez, 82 F.3d 574, 577 (2d Cir.1996)) (internal quotation marks omitted). In determining whether an adequate basis exists for a return of capital charge, we must first determine the extent and nature of the showing the defendant must make. 24 Although our earlier cases have not stated it with perfect clarity, a defendant does always bear the burden of production--under which the defendant must make an initial showing on each key element of the theory--to receive an instruction on the return of capital theory. That is, there must be some credible evidence that the corporation did not enjoy income or profits for the tax year at issue, and that the amount of the taxpayer's capital contribution exceeded the amount of the distribution from the corporation. The court in Leonard effectively held as much: 25 In prosecutions for income tax violations, production of a rather slight amount of evidence by the Government, here the proof of receipt of what are charitably characterized as constructive dividends rather than embezzled funds, may transfer the burden of going forward to the defendant. Although the ultimate burden of persuasion remains with the Government, Leonard did not introduce sufficient evidence of an absence of earnings or profits.... 3 26 524 F.2d at 1083 (citations omitted). Though Leonard used precatory language in discussing the defendant's burden of production, it did not purport to do away with the general requirement that a proposed jury instruction must have an adequate basis in fact. To the extent that Leonard was at all unclear on the issue, we now clarify that in order to merit a charge on the return of capital theory, a defendant must satisfy a burden of production by showing that an adequate basis in fact exists for the charge. As suggested by the cases cited in Leonard, 524 F.2d at 1083, this is not the only circumstance in which a taxpayer faces a burden of production once the government has come forward with evidence of tax evasion. See, e.g., United States v. Vardine, 305 F.2d 60, 63 (2d Cir.1962) ([I]t is reasonable to require the defendant, if he wishes to disprove intent and likely source [of a net worth bulge], to bear the burden of going forward when he alleges that he had additional deductions not claimed on his income tax return.). Of course in cases involving the return of capital theory, the allocation of the burden of going forward to the taxpayer does not affect the ultimate burden of persuasion, which always remains with the government. See Leonard, 524 F.2d at 1083. 27 Like the taxpayer in Leonard, Bok failed to satisfy his burden of going forward and therefore did not establish an adequate basis in the record for his proposed instruction. Specifically, neither Bok nor the government produced any admissible evidence to suggest that Abacus lacked earnings or profits for 1988. Although Bok did introduce Abacus's 1988 financial statements, he made clear that they were offered only to show Bok's state of mind when he gave information to his accountant, not for the underlying truth of the figures in the statements. Even if the financial statements had been admitted for their truth, they alone would not have satisfied Bok's burden because they were based entirely on information provided by Bok, purportedly using an entirely different method of accounting than that used on Abacus's corporate return. 4 In addition, Bok had suggested that Abacus did have net earnings for 1988. During the IRS's investigation, Bok accounted for the low figures in the gross receipts portion of Abacus's return by explaining that he had mistakenly entered the corporation's net profits in place of its gross receipts. At trial Bok referred to this explanation for the false statements on Abacus's returns in arguing that he lacked the requisite intent to be convicted. Bok continues to make the same argument on appeal, noting his contention that the numbers on the gross receipts line of Abacus's tax returns were really net profits. Brief for Defendant-Appellant David S. Bok at 36. Finally, Bok declined the trial court's invitation to elicit facts to support his proposed charge. Because Bok's accountant had not been qualified as an expert witness, the trial court rejected Bok's attempt to establish through the cross examination of the accountant that, as a matter of law, a return of capital was a nontaxable event. In doing so, however, the trial court expressly suggested that Bok use the witness to develop facts that Bok might later use as the basis for a jury instruction; Bok did not follow up on the trial court's suggestion. 28 Thus, despite our generous approach to jury instructions, under which the defendant is entitled to an instruction on his theory when there is some foundation in the proof, no matter how tenuous, Dove, 916 F.2d at 47, Bok did not provide sufficient facts to warrant his proposed charge. Given the lack of evidence produced by Bok on the issue of Abacus's earnings or profits, we cannot say the trial judge erred in finding no basis in the record for the return of capital theory. Because Bok failed to satisfy his burden of production, the trial court properly rejected Bok's proposed instruction.