Document: 489 U.S. 726 109 S.Ct. 1455 103 L.Ed.2d 753 COMMISSIONER OF INTERNAL REVENUE, Petitionerv.Donald E. CLARK et ux. No. 87-1168. Argued Nov. 7, 1988. Decided March 22, 1989. Syllabus Under the Internal Revenue Code of 1954, gain resulting from sale or exchange property is generally treated as capital gain. Although imposes no current tax on certain stock-for-stock exchanges, § 356(a)(1) provides that if such an pursuant to a corporate reorganization plan accompanied by cash payment other property—commonly referred "boot"—any which recipient realizes in year up value boot. However, 356(a)(2) creates exception, specifying "exchange . has effect distribution dividend," boot must be dividend and therefore appropriately taxed ordinary income extent realized. In 1979, respondent husband (hereinafter taxpayer), sole shareholder Basin Surveys, Inc. (Basin), entered into "triangular merger" agreement with NL Industries, (NL), whereby he transferred all Basin's outstanding shares NL's wholly owned subsidiary for 300,000 shares—representing approximately 0.92% common stock—and substantial On their 1979 joint federal return, respondents reported 356(a)(1). agreeing merger at issue qualified purposes section, Commissioner assessed deficiency against respondents, ruling had "the dividend" under 356(a)(2). review, Tax Court held respondents' favor, Appeals affirmed. Both courts rejected test proposed determining whether requisite effect, would though it were made hypothetical redemption acquired corporation (Basin) immediately prior reorganization. Rather, both accepted applied post-reorganization urged taxpayer, requires pure imagined, followed portion taxpayer's acquiring (NL) return amount equal The ruled 125,000 its taxpayer was subject gains treatment 302 Code, defines stock shareholders. Held: Section 356(a)'s language history, well commonsense understanding economic substance transaction issue, establish rather than treatment. Pp. 737-745. (a) 356(a) strongly supports view question should answered examining whole. By referring "exchange," plainly contemplate one integrated make clear character whole not simply component parts examined. Moreover, fact 356 expressly limits may realized suggests Congress intended isolation overall 737-738. (b) Viewing this case whole, pre-reorganization analogy unacceptable, since severs context reorganization, adopts overly expansive reading contrary Court's standard approach construing statutory exception narrowly preserve primary operation general rule. 738-739. (c) postreorganization preferable adopted, does far better job treating exchange. approach, easily satisfied 302(b)(2), specifies redemptions relinquishes more 20% his control thereafter retains less 50% voting shall distributions. 739-740. (d) Commissioner's objection "recasting [of] transaction" ground forces find where none existed overstates imagined. Since tax-free is, theory, merely continuance proprietary interests continuing enterprise modified form, boot-for-stock can viewed partial repurchase enterprise—i.e., redemption. prereorganization analogies "recast transaction," latter least recognizes taken place. 740-741. (e) Even principles abandoned favor artificial transaction, result same. legislative history primarily concerned preventing corporations evading "siphon[ing] off" accumulated earnings profits rate through ruse This purpose turn did intend impose accompanying involves bona fide, arm's-length between unrelated parties instant there indication th t used ruse. Thus, characterized part proceeds proxy dividend. 741-745. 828 F.2d 221 (CA 4 1987), STEVENS, J., delivered opinion Court, REHNQUIST, C.J., BRENNAN, MARSHALL, BLACKMUN, O'CONNOR, KENNEDY, JJ., joined, but Part III SCALIA, joined. WHITE, filed dissenting opinion, post, p. 745. Alan I. Horowitz, Washington, D.C., petitioner. Walter B. Slocombe, respondents. Justice STEVENS Court.* 1 third Government asked us decide shareholder's receipt taxable two earlier cases, v. Estate Bedford, 325 283, 65 1157, 89 L.Ed. 1611 (1945), United States Davis, 397 301, 90 1041, 25 323 (1970), we agreed largely because transactions involved single "result meaningful reduction proportionate interest corporation." Id., 313, 1048. today, however, taxpayer1 exchanged 1% payment. conclude We accordingly agree entitled 2 * liability gain, whereas dividends income.2 exchanges. particular, 354(a)(1) provides, various limitations, nonrecognition securities solely securities, provided are those party reorganization.3 26 U.S.C. 354(a)(1). 3 additional consideration form property—something practitioners refer "boot"—"then any, recognized, excess sum money fair market property." That receives boot, she recognize Boot recognized year. 356(a)(2), controls decision case, It 1979: 5 "If described paragraph (1) dividend, then each distributee ratable share undistributed after February 28, 1913. remainder, (1976 ed.). 6 contrast, have and, insofar realized, accorded thus within meaning 7 relevant facts summarized. For 15 years April president (Basin). January 1978, became Basin, company invested $85,000. operated successful business providing technical services petroleum industry. N.L. publicly engaged manufacture supply equipment services, initiated negotiations regarding possible acquisition Basin. 3, months negotiations, contract. 8 merger," merged NL. transferring subsidiary, elected receive $3,250,000, passing alternative offer 425,000 stock. issued amounted If instead offer, 1.3% shares. qualifies §§ 368(a)(1)(A) (a)(2)(D).4 9 Respondents 1979. As required 356(a)(1), they calculating owed, long-term audit disagreed characterization. view, $2,319,611, time merger. $972,504.74. 10 petitioned review which, reviewed decision, favor. 86 T.C. 138 (1986). court started premise turns choice "two judicially articulated tests." 140. advocated given voice Shimberg States, 577 283 (CA5 1978), cert. denied, 439 1115, 99 1019, 59 73 (1979), test, received indisputably been dividend.5 second finding support Wright 482 600 (CA8 1973), proposes Rather concentrating corporation, imagine exchange, when $3,250,000 gain.6 11 favored considered improper "to isolated event totally separate reorganization." T.C., 151. Indeed, suggested "determination equivalency fantasizing exist." 150 (footnote omitted). acknowledged similar criticism could contention concluded, perfectly place without treat "as equivalent course implementing reorganization," having occurred 152 (emphasis original).7 12 Fourth Circuit (1987). Like concluded although "[s]ection explicitly apply context," id., 223, differs important respects, 224, nonetheless appropriate gain," 223. explicated relinquished retained distribution, "[b]ecause designed deal involving companies, section indicate [the taxpayer] lost in." 224. like left consider coming corporation. concluded: 13 "Based 356, change-in-ownership principle 302, need affected taxpayer's] new Because reduced holdings 20%, gain." 224-225. 14 conflict Fifth (1978), respects. Shimberg, inappropriate cases "on wholesale basis." 287; see also ibid., n. 13. addition, adopted holding "§ determination occurred." 288. To resolve importance administration laws, granted certiorari. 485 933, 108 1106, 267 (1988). II 16 " xchange think statute, approach. 17 our asks "an (1)" "has dividend." (Emphasis supplied.) statute provide inquiry "exchange" effect. (1), turn, looks consists only permitted 354 355 recognition money." Again, refers again, makes look parts. Finally, significant limitation See Levin, Adess, & McGaffey, Distributions Corporate Reorganizations—Determination Dividend Equivalency, 30 Lawyer 287, 303 (1977). 18 Our requiring unified reinforced well-established "step-transaction" doctrine, doctrine related contexts, see, e.g., Rev.Rul. 75-447, 1975-2 Cum.Bull. 113, sanctioned, Minnesota Tea Co. Helvering, 609, 613, 58 393, 394, 82 474 (1938); Holding Co., 324 331, 334, 707, 708, 981 (1945). interrelated yet formally distinct steps independently transaction. "linking together interdependent legal significance, taking them isolation," based realistic entire transaction." Bittker, Federal Taxation Income, Estates Gifts ¶ 4.3.5, 4-52 (1981). 19 unable accept analogy. straining abstract imagining planned acquisition, reach counterintuitive conclusion Commissioner—that suffered ownership limited inconsistent statute's direction 20 further flawed adoption most reorganizations usually distributed pro rata shareholders target F.2d, 227; Golub, "Boot" Reorganizations—The Equivalency Test Taxes 904, 911 (1980); Note, Boston College L.Rev. 601, 612 (1979). Such constitute r widely criticized "automatic rule" (at corporation), 8, supra, provisions. requirement some circumstances rule authorizing provisions statement policy read order provision. Phillips, Walling, 490, 493, 807, 808, 1095 (1945) ("To extend exemption unmistakably terms spirit abuse interpretative process frustrate announced will people"). Given enacted treats eviscerate judgment somewhat ambiguous exception. 21 Most significantly, Unlike acknowledges absent that, accepting payment, experienced potential interest. 22 Once pellucidly clear. 302(a) fits any four categories set out 302(b), "shall full stock," regarded correctly determined, satisfies subsections 302(b).8 safe harbor subsection (b)(2) her corporation's distributions 6, supra. Here, redeemed (i.e., number forgone boot) boot). redemption, 0.9%. 153. 29% satisfying "substantially disproportionate" standards 302(b)(2). properly 23 objects different parties," Brief Petitioner 11, argues Appeals' formal adherence pri ciples embodied forced stretch "find them, involve redemption," 28. There sufficient responses argument. first worth emphasizing noted "[t]he theory behind 'a form.' Lewis Revenue, 176 646, 648 (CA1 1949); Treas.Reg. 1.368-1(b). Cohen, Conglomerate Mergers Taxation, 55 A.B.A.J. 40 (1969)." result, i.e., course, true outside confines actual choose analogies, artificial. place, while recasts exclusion 24 doubt abandoning lead reached Appeals. admittedly sparse, persuaded—even relying except here allowing perhaps "not illuminating," U.S., 290, S.Ct., 1160, Taxes, 905. served denying interest, exchanging finds genesis 203(d)(2) Act 1924. 43 Stat. 257. slightly over years, identical. House Report asserts "preven[t] evasion." H.R.Rep. 179, 68th Cong., 1st Sess., (1924). Without explication, Senate Reports rely example explain, words Reports, necessity provision." Ibid.; S.Rep. 398, Significantly, describes situation change stockholders' relative interests, creation mechanism making shareholders: "Corporation A $100,000, 1, 1913, $50,000. distributes $50,000 stockholders, surtax rates. 27 "On hand, Corporation organize B, transfers assets, cons deration transfer being issuance B stockholders A. existing law, taxed, 121/2 per cent rate. obviously same declared profits. rates, so rates 15. 28 "effect" altering respective enterprise. 29 Of understood exhaustive proper applications noteworthy neither example, nor source, evinces congressional intent fide contrary, avoiding evasion cases. well. explaining "essentially 302(b)(1)—language certainly 356(a)(2)—the Finance Committee "whether nature ." 1622, 83d 2d 234 (1954); cf. 311, 1047. Examining light "may stock." unlike traditional commonly corporations, little risk distribute appears respects narrow before comparable conclusion, moreover, supported findings Court. found "[t]here slightest evidence concealed BASIN." 155. noted, lacked funds distribution: 31 "Indeed, hard conceive possibility even considered, ($2,319,611), total assets BASIN ($2,758,069). fact, takes account unrealized appreciation BASIN's including good and/or going-concern value, possibly arrive $3,250,000. complete liquidation BASIN. Ibid.9 32 context, analogy, roceeds such, 33 34 Affirmed. 35 dissenting. 36 Donald Clark, 18, Acquisition (NLAC), ed.), Petitioner, (Commissioner), determination, taxing income, disagreed, stating resembles (CA4 1987). majority today agrees characterization, spite Clark's explicit refusal imagined majority, record demonstrates, instead, 356(a)(2)—and hence alerted deficiency—I dissent. 37 stipulated. NL, NLAC executed Agreement Plan Merger dated merge NLAC. merger, (a)(2)(D) status 354(a)(1), following terms: Each remained outstanding; $56,034.482 5,172.4137 stock; canceled. NLAC's name amended Secretary State West Virginia certified complied law. owner He refused cash. App. 56-59. 38 grant favorable specific (reorganizations) securities. Paulsen Commissioner, 469 131, 136, 105 627, 630, 83 540 (1985) (citing 1.368-1(b), CFR 1.368-1(b) (1984), noting distinctive feature reorganizations, namely, continuity interests). 368(a)(2)(D). supplemented provision taxpayers withdraw during declaring states distributee's "ratable (1924) (illustration 356(a)(2)'s taxation distributions); (same). 39 Thus Clark supplied straightforward answer 306, 312, 1044, 1047, explained equivalent" stock, alteration basic relationships, hallmark precisely necessarily moneys exceeded $2,319,611. obligation simultaneously approved assumes continue restructured NLAC, exact source immaterial, truth distribution. avoid Appeals—approved today—recast (NL's) determined according Code. shields loss percentage hypothesized completed receiving shares, these escapes theoretically declined 0.92%, adequate trigger 302(b)(2) protection. Transporting sales equity back own problematic. Neither explains why obscure core attribute shareholders;1 offers insight mechanics valuing reductions; answers observations always smaller payments combine Last, recharacterization happenings supplement, 41 chose structure I dissent.2 SCALIA joins opinion. Respondent Peggy S. action husband, Clark. References "taxpayer" question, distinction considerable importance. 1202(a) ed., Supp. III), allowed individual deduct 60% net gross income. dramatically 1986 repeal 1202(a), Reform 1986, Pub.L. 99-514, 301(a), 100 2216, still 1211(b) (1982 IV) allows losses gains, offset $3,000 exceed gains. Title 368(a)(1) several types reorganizations. They include, part: "(A) consolidation; "(D) another transferor, o (including persons who transfer), combination thereof, transferred; if, pursuance plan, 354, 355, 356; "(E) recapitalization; "(F) mere identity, organization however effected. 368(a)(2)(D) "The acquisit (referred subparagraph 'controlling corporation') substantially properties disqualify (1)(A) (i) controlling (ii) do equivalence reference concerns Compare 28-30 18-24. essential agreement, about characteristics "basic derived Sections 301 316 When 'the fundamental equivalency' shareholders' (United 306 [90 323] (1970))." 7. Citing authority, emphasis, non-dividend 'meaningful corporation.' 313 1048, (1970)." rief 5. either shareholder, resulted "meaningful [taxpayer's] [Basin]." "(a) General redeems (within 317(b)), (2), (3), (4) applies, "(b) Redemptions exchanges "(2) Substantially disproportionate "Subsection respect shareholder. "(B) Limitation "This unless owns 50 percent combined power classes vote. "(C) Definitions "For paragraph, if— "(i) ratio bears time, "is 80 of— "(ii) time. (whether nonvoting) meets preceding sentence. explained, 0.92%. 138, 153 71% what Ibid. "distribution" stressed adopt "would resurrect now discredited 'automatic rule' ., 152. appeal, agreed. 221, 226-227 developed imprecise Bedford recapitalization employed broad language, asserting "a 'has dividend' [§ ]." 292, 1161. establishing matter law 56-220, 1956-1 191. Commentators, Darrel, Scope Estate, 266 (1946); Shoulson, Taxation: Blunt Toe Automatic Rule, 573 (1965), courts, Hawkinson 235 747 (CA2 1956), soon came criticize long retreated rule," Idaho Power 161 F.Supp. 142 Ct.Cl. 534, 358 832, 79 53, 70 (1958), suit, 74-515, 1974-2 118. plain, require dividends. mechanical requirements met, might qualify essentially (b)(1). Subsections (b)(3) (b)(4), liquidations, respectively, case. maintains "could (see, I.R.C. 312(a)(2)) borrowed Reply financial status, strong zeal excoriate leads opposite rigidity—an automatic nondividend rule, payments. Any automatically attributes disappears. handicap absolute; instructs fact-specific inquiries occur basis threaten bailout transferor escaping majority's all—rather sale—is difficult understand: All stipula e law; endorsed exactly regime. However apt speculated be, amounts $10 million. fracas irrelevant.

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