Opinion ID: 357068
Heading Depth: 2
Heading Rank: 1

Heading: the failure to determine the existence of a constructive dividend

Text: 43 We begin our review of this finding by noting that the determination of a constructive dividend entails two separate inquiries. First, the trial court must determine whether a constructive dividend was conferred. Then, and only then, need the trial court focus on a computation of the amount of such a dividend. United Aniline Company v. Commissioner of Internal Revenue, 316 F.2d 701 (1st Cir. 1963); Challenge Manufacturing Co. v. Commissioner, 37 T.C. 650 (1962). 44 While these determinations necessarily are entwined to a degree, it is impermissible to find the presence of a constructive dividend simply because the value of a benefit conferred exceeds the payments made in compensation. One of the underlying problems with the district court's treatment of the constructive dividend issue in the present case is its apparent failure to demonstrate that it performed both segments of this two part operation. 45  Not every corporate expenditure incidentally conferring economic benefit on a shareholder is a constructive dividend. Crosby, 496 F.2d at 1388. Before determining the amount of a constructive dividend, the court must determine whether the distribution was primarily for shareholder benefit. Sammons v. Commissioner of Internal Revenue, 472 F.2d 449 (5th Cir. 1972). Unfortunately, the line between primarily for shareholder benefit and primarily for corporate benefit is one not susceptible to easy delineation. Crosby, 496 F.2d at 1389. 46 An example of the danger attendant to a failure to undertake both parts of this inquiry is provided by Gibbs, supra. There, the court dissected a transaction in which stockholders leased their property to their corporation. A portion of the lease required the corporation, at its own expense, to make certain improvements on the property. The corporation was to be paid from the rental payments due under another lease in which an unrelated corporation was the lessee. The court began by explicitly splitting the determination into two parts: the existence of a dividend and secondly, its amount. As to the first determination, the Gibbs court noted that 47 (t)he crucial consideration with regard to whether a dividend resulted to taxpayer is whether it was intended that taxpayer was to pay the corporation for the work. 48 Gibbs, 362 F.2d at 397. In accordance with this principle, the court decided that the transaction at issue embodied a constructive dividend since stockholder's corporation only would receive payments for the construction work done if the unrelated corporation did not default on its lease payments. Because the linkage of lease payments with payment for improvements was not placed in the improvements contract until after the unrelated corporation had defaulted, the court found that there was no expectation of repayment sufficient to stave off a finding of a constructive dividend. 49 Another example of the fundamental importance of the initial determination may be found in Benes v. Commissioner, 42 T.C. 358 (1964). Confronted with a stockholder whose corporation had undertaken a series of improvement on a piece of property eventually serving as his residence, the court first decided that these expenditures were primarily for the stockholder's benefit. This presented a close question in that the property, at the time the improvements were made, ostensibly was not being utilized for his purposes. Had the court merely assumed the existence of a constructive dividend because of a difference between the value of the improvements made and the payments rendered by the stockholder on a piece of property connected with the stockholder's name, it would have overlooked the possibility that the improvements were not conferred for his benefit. 50 Finally, in Crosby, the court dissected the transactions which allegedly served as the basis for constructive dividend treatment from the required two part perspective. Here, the corporation made improvements on its stockholder's land after the stockholder had conveyed the land by deed to the corporation. In pursuit of the primary determination that must be made in a constructive dividend suit whether a benefit was conferred primarily for the stockholder's benefit the court discovered that the only property right which the corporation had accrued through the transfer of the deed was the limited right to sell the property. An investigation of the substance of this transaction convinced the court that the underlying purpose of the improvements made was the provision of a stockholder benefit. Had the Crosby court merely accepted this transaction at face value, it would have overlooked the existence of an economic benefit conferred by the corporation without expectation of repayment and, as a result, overlooked a potential constructive dividend. 51 It is clear from Benes, Gibbs and Crosby that the comparison of the value of the benefit conferred and the payments made in reimbursement cannot serve as the predicate for the finding of a constructive dividend. A prerequisite to the measurement of a dividend is the determination of its existence. The importance of this prerequisite is underscored by the apparent failure of the district court in the present case to have satisfied it. The court measured and determined the dividend simultaneously. It proceeded on a year by year basis, comparing payments made with costs incurred. Leaving aside the question of whether this was the proper method for computing the dividend herein, 15 it is clear that such an approach will elicit the presence of a dividend whenever payment is made in a year other than the one in which the costs relating thereto are incurred. In a contract requiring the rendering of services over a period of several years, the use of this method of measurement as the means by which the court determines the preliminary issue of whether a benefit was conferred primarily for stockholder benefit without expectation of repayment can produce an ill-conceived result. 52 In the case sub judice, the lower court reasoned that the absence of a payment (or sufficient payments) by the partnership in a particular year signaled that the corporation did not expect repayment. As a result, a constructive dividend was assessed. This is the reasoning which appears to have been the predicate, albeit a sub silentio predicate, for the district court's determination of a dividend. 16 53 We believe that this reasoning places the cart before the horse. By reasoning in this manner, the district court was measuring the dividend prior to determining that one had been conferred. The district court stated that it operated upon the premise that a constructive dividend occurs when a corporation confers an economic benefit on its shareholders without expectation of repayment. App. 180-181. On its face, this would appear to satisfy the obligation of the district court with regard to the primary determination entailed in a constructive dividend suit. However, it is clear from an examination of the record that this statement was made only in relation to the numerous cash withdrawals made by stockholders Loftin and Woodard not in relation to the land clearing operation. As to this operation, which constituted the major part of the constructive dividend finding, the court was silent on the question of whether it performed the required first-part determination. And the classification of the cash withdrawals as constructive dividends the subject of the court's statement is not before us on this appeal. 54 Thus, in contrast to the clarity with which the court approached the dividend issue in relation to the cash withdrawals is the treatment it accorded to the dividend issue in relation to the land clearing operation. It does not appear from the record that the district court ever determined that the land clearing operation was a distribution conferred primarily for shareholder benefit. Instead, it appears that the district court assumed that in any year when the payments made by the partnership did not match the costs incurred by the corporation, a distribution was made primarily for the partners' benefit. 55 The danger of not maintaining a separation between the two parts of the constructive dividend determination cannot be overstated. 56 It might be argued that the non-expectation of repayment was demonstrated with such clarity that there was no need for an explicit finding in this regard. While such an argument might succeed in a limited number of cases, we are not pointed to any facts which support such an approach here. 57 For example, the initial spreading of costs by the Corporation among its other projects and the failure to make a payment until December 31, 1964 are cited as significant in this regard. In addition, the Government emphasizes the failure of the stockholders to be guided by the advice of their own accountant with regard to the constructive dividend that would arise from the benefits accruing from the land clearing operation. 58 As to the use of the spreading of costs as a fact indicating that the district court made the required first-part determination, this does not demonstrate that the Corporation did not expect repayment. 17 Testimony at trial indicated that the initial spreading of the costs incurred at Yazoo among the general expenses of a corporation the size of this corporation was not highly unusual. 18 We cannot disregard the fact that the Corporation did begin expensing the land clearing costs to a separately identifiable category once the project was in full swing. Indeed, this change occurred prior to the time that the IRS began its initial audit. 19 Thus, the change was not undertaken in an effort to cover corporate tracks. 59 As to the advice rendered by the Corporation's accountant, Savage, it is true that he advised the stockholders not to authorize the Corporation to clear the land prior to the transfer of that land to the partnership because of the possibility of a constructive dividend arising therefrom. However, Savage was not concerned with the type of constructive dividend that arises when the value of the services rendered exceed the payments made for such services that is, the constructive dividend at issue here. Rather, Savage was concerned over the possibility that the corporate clearing efforts would enhance the value of the property so much that when the Corporation transferred the property to the partnership, the incremental appreciation of the land's value would be fully taxable at that time. 20 60 In sum, it is unclear whether the district court determined that a constructive dividend was conferred prior to the court's measurement of such a dividend. Given the guidance of Benes, Gibbs, and Crosby, this is a determination which must be made. The district court is instructed to make this determination consistent with this opinion. 61 While this would be sufficient, alone, to support a remand for reconsideration of the deficiencies assessed against taxpayers on the basis of the Yazoo clearing, we believe that there are other problematic aspects of the district court's approach to this issue. In the interest of justice and judicial efficiency, we discuss them now.