Court Opinion

ID: 4479788
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:13:51.657591+00
Date Added: 2024-06-11T14:53:36.040834
License: Public Domain

Dawson, J., dissenting: I respectfully disagree with the majority opinion. After having heard the evidence in this case, I am convinced that the redemption here in question — motivated as it was by bona fide business considerations on the part of Boogaart Supply Co., Inc., and resulting as it did in the improvement in the credit position of that corporation — was not the essential equivalent of a dividend within the meaning of section 302 (b) (1). While the majority recognize that with the passage of the 1954 Code the law with respect to stock redemptions was substantially recast, S. Rept. No. 1622, 83d Cong., 2d Sess., p. 49 (1954); Ballenger v. United States, 301 F. 2d 192 (C.A. 4, 1962), their statement, to the effect that the evidentiary criteria useful in determining dividend equivalency under section 302(b)(1) remain substantially the same as those formulated by the courts for making a like determination under prior law, i.e., section 115 (g) of the 1939 Code, appears to be incorrect. Section 115 (g) and its predecessor sections contained what has been termed a “delphic proscription” against redemptions which were the “essential equivalent” of a dividend. However, it was early recognized that the term “essentially equivalent to a dividend” had little inherent meaning. In the evolution of the law relating to redemp-tions the courts, therefore, developed certain criteria whose presence or absence was thought to be helpful in making the factual determination as to whether a particular redemption was or was not “essentially equivalent to a dividend.” In commenting upon the state of the law as it existed under the 1939 Code, we said that while— There is no sole decisive test * * * a number of judicial criteria or guideposts have been determinative in placing a transaction within section 115(g). Among these criteria are: The presence or absence of a bona fide corporate business purpose; whether the action was initiated by the corporation or by the shareholders; did the corporation adopt any plan or policy of contraction, or did the transaction result in a contraction of the corporation’s business; did the corporation continue to operate at a profit; whether the transaction resulted in any substantial change in the proportionate ownership of stock held by the shareholders; what were the amounts, frequency, and significance of dividends paid in the past; was there a sufficient accumulation of earned surplus to cover the distribution, or was it partly from capital, [citing authorities] [Genevra Heman, 32 T.C. 479, 486 (1959), affd. 283 F. 2d 227 (C.A. 8, 1960).] With respect to the 195J¡, Code, although it is true that in general section 302(b)(1) was intended to incorporate existing law as embodied in section 115(g) of the 1939 Code,1 the words “in general” must be stressed for the new provisions were not made fully coextensive with the old. Thomas G. Lewis, 35 T.C. 71 (1960). Consequently, because of the distinction which is drawn by the 1954 Code between part I of subchapter C and part II thereof,2 certainly those factors mentioned in Heman, supra, dealing with corporate contraction are no longer germane to an inquiry under section 302(b) (1). Corporate contraction, as a measure of nondividend equivalency, arose under earlier law by virtue of the fact that section 115(c) of the 1939 Code provided that any distribution in cancellation or redemption of stock was a distribution in liquidation, and distributions in liquidation were treated as in exchange for stock canceled or redeemed. An exception, however, was created by section 115 (g) in cases where the Stock was canceled or redeemed at such time and in such manner as to make the distribution essentially equivalent to a dividend. Thus all distributions, whether viewed from the corporate level (liquidations) or from the shareholder level (redemptions), were ultimately tested for dividend equivalency by section 115 (g). Because they were required to utilize section 115(g) to test the dividend equivalency of distributions both in redemption and in liquidation, it was only natural that the courts should develop the corporate contraction rationale3 in connection with section 115(g). The 1954 Code, however, was designed to treat separately distributions in liquidation (sec. 346) from those in redemption (sec. 302).4 Since the corporate contraction rationale has meaning only in conjunction with distributions in liquidation, and since the dividend equivalency of liquidating distributions is tested by section 346, it follows that corporate contraction, as a measure of dividend equivalency, is now pertinent only to section 346, and has no meaning with regard to section 302.5  Similarly, the question of whether the transaction resulted in any substantial change in the proportionate ownership of stock held by the shareholders has assumed a lesser degree of importance in making a determination of 302(b) (1) dividend equivalency by reason of the enactment of sections 302(b) (2) and 302(b) (5) .6 Additionally, Congress has manifested an intention that in the future application of of the section 302(b) (1) test, “the inquiry will be devoted solely to the question of whether or not the transaction may properly be characterized as a sale of stock by the redeeming shareholder to the corporation. For this purpose the presence or absence of earnings and profits is not material.”7 S. Rept. No. 1622, 83d Cong., 2d Sess., p. 234 (1954). Thus, of the seven criteria noted in Heman as useful in determining dividend equivalency under section 115, only the following are pertinent to the present inquiry under section 302(b) (1) : The presence or absence of a bona fide corporate business purpose; whether the action was initiated by the corporation or by the shareholders; what were the amounts, frequency, and significance of dividends paid in the past. These are the criteria which are to be applied in making the general factual determination as to “whether or not the transaction by its nature may properly be characterized as a sale of stock by the redeeming shareholder to the corporation.” This approach to the question of dividend equivalency is not the direct antithesis of the so-called “net effect” test,8 but merely allows that a redemption of stock can have a business purpose justification sufficient to overcome its resemblance to a dividend under the “net effect” test. Although the majority would seem to agree that “business purpose justification” for the redemption is the critical factor here,9 as they view the facts “the distribution made to each of the petitioners on September 27,1958, does not appear to have been made in furtherance of any corporate purpose but, on the contrary, appears to have been made merely for a stockholder purpose.” At the outset, it may be observed that, “In cases such as this, in which the stockholder-taxpayer[s] and the principal if not as a practical matter the only corporate officer [s] are one and the same * * *, it is difficult, to say the least, to distinguish between corporate purposes on the one hand and stockholder purposes on the other for [a] transaction of the kind involved.” Keefe v. Cote, 213 F. 2d 651, 657 (C.A. 1, 1954). Yet, as the trier of fact, I am convinced that the sole purpose of the transaction in question was to benefit Boogaart Supply Co., Inc. In making what has always been a purely factual determination, see sec. 29.115-9, Regs. 111; sec. 1.302-2(b), Income Tax Regs.; Jones v. Griffin, 216 F. 2d 885, 887 (C.A. 10, 1954), I view the Boogaart interests, almost from their inception, as being in a constant state of expansion but plagued by insufficient working capital. Individual borrowings by the partners, the partnership, and the corporation had hithertofore failed to furnish sufficient capital. Public sale of corporate debentures in 1954 and 1955 had been of some assistance, but still plans for expansion outstripped available capital. During the course of financial discussions in the summer of 1958 investment counsel proposed that any further underwriting of corporate issues would have to be accompanied by the corporation’s acquisition of the four grocery stores in order to better its financial picture. The singular purpose of the redemption under scrutiny was to provide a mea/ns for Boogaart Supply Co., Inc., to acquire the four retail grocery store corporations needed by it to bolster its credit position. That this was the purposes of the redemption, and that this purpose was achieved, is adequately evidenced by the fact that prior to the redemption all borrowings of the Boogaart-Sorem group had been on a first-mortgage secured-note basis upon which the partners were individually liable, while after the redemption Boogaart Supply Co., Inc., was able to secure a half-million-dollar open line of credit with a Chicago bank. Historically speaking, the major purpose of section 302(b), section 115 (g), and their predecessor sections was and is to preclude the tax avoidance possibilities inherent in allowing corporate distributions, taxable at capital gains rates, to be made in the presence of earnings and profits. Thus, in any factual determination of the dividend equivalence of a distribution in redemption, the presence or absence of a tax avoidance motive becomes a critical inquiry. Motive of any sort, however, is subjective. While the existence of a bona fide business purpose motivation is anathema to tax avoidance, this, too, is subjective. Yet, subjective intent in the instant case can readily be established by objective manifestations — what the petitioners said they intended, corroborated by events which actually took place. Here, petitioners say the purpose of the redemption was to allow Boogaart Supply Co., Inc., to acquire the grocery stores to improve its credit position. By means of the redemption the corporation did so acquire the grocery stores, and as a result thereof its credit position was demonstrably improved. Improvement in the credit position of a corporation has been held by this Court to be a business purpose sufficient to overcome the resemblance of a redemption to the distribution of a dividend. Bona Allen, Jr., 41 B.T.A. 206 (1940). In that case corporate stock was redeemed pro rata to reduce stockholder indebtedness to the corporation in order that the corporation might have the high credit rating necessary for borrowing at extremely low rates of interest. There being no proof of a tax avoidance motive, the Court, finding that the sole motivation for the transaction was to improve the credit position of the corporation, held the redemption not essentially equivalent to a dividend. An argument was made by respondent questioning whether there actually was a business purpose for the redemption, since the same result could have been obtained by a cash distribution out of earned surplus sufficient to allow the shareholders to repay their indebtedness to the corporation. This contention the Court summarily rejected on the ground that the record indicated “the necessity for the retention of cash at all times by the corporation * * * obviously the corporation could not with safety to its business pay out all of its cash to the stockholders.” The same observation may be made with regard to Boogaart Supply Co., Inc. In a state of expansion, seeking outside financial backing, the distribution of a dividend by that corporation out of accumulated earnings would certainly have been financially foolish and totally inconsistent with the established corporate purpose of improving balance sheet viability. But a purchase of stock at book value, representing assets worth far in excess of such value — and what is more, representing improved ability to repay loans with profits from retail stores10— was totally consistent with the corporation’s declared aim. The majority state that “while the record * * * discloses a business purpose underlying the realignment of the corporate structure of the related wholesale and retail grocery businesses, we are unable to conceive how the distribution by Boogaart Supply Co., Inc., of $88,-349.62 in cash, or its equivalent served in any way to improve its balance sheet or strengthen its credit position.” However, Boogaart Supply Co., Inc., received, in exchange, not only stock having a book value equal to what was paid out, but which represented, as pointed out above, assets having a real value far in excess of the book value of the stock. While it is true that the corporate records would only reflect the book value of the stock, it was obvious that by reason of the acquisition, corporate earning power and ability to repay loans were increased many fold. It has been suggested, however, that the same result, i.e., corporate acquisition of the four grocery stores, could as easily have been accomplished by a section 368 reorganization — with consequences to the parties determined by sections 351 and 1032 — thus eliminating the need for any distribution by Boogaart Supply Co., Inc. It is further suggested that because of this there was no need to utilize redemption as a method of acquiring the four grocery stores, the inference being that there would be no business purpose for it. I disagree in no uncertain terms. The question here is not whether the same result could have been obtained without a corporate distribution, but whether the redemption, to which the distribution was a necessary concomitant, served a justifiable business purpose. Jones v. Griffin, supra at 890. In this case there is no doubt but that it did. Therefore, in accordance with the congressional intent as to the nature of the section 302(b) (1) inquiry, it is my opinion that the instant transaction should be characterized as a sale of stock by Sorem and Boogaart to the corporation. Fishes and Scott, //., agree with this dissent.   See S. Rept. No. 1622, 83d Cong., 2d Sess., pp. 333-334 (1954).    See majority opinion, fn. 15, supra.    Based on the theory that If there ■was a contraction of the corporate business and If the distribution was In liquidation of assets no longer needed as a result of that contraction, the distribution was not essentially equivalent to a dividend since a dividend was a distribution of the profits of a continuing business operation.    “distributions In redemption of stock which qualify as distributions in complete or partial liquidations under Part D of subehapter C [specifically secs. 331 and 346, X.R.C. 1954] are not within the scope of section 302.” S. Rept. No. 1622, 83d Cong., 2d Sess., p. 233 (1954).    Moreover, those cases which applied the corporate contraction rationale appear to have looked exclusively to the source of the funds or property with which the redemption was effected. Under the 1954 Code “those distributions characterized by what happens solely at the corporate level by reason of the assets distributed would be Included as within the concept of a partial liquidation” and therefore treated under sec. 346. S. Rept. No. 1622, 83d Cong., 2d Sess., p. 49 (1954).   Indeed, the legislative history leaves some doubt as to whether the substantial disproportion of a redemption among the shareholders is a consideration pertinent to the 302(b)(1) inquiry at all. Sec. 302(b)(5) provides in part, that In determining whether a redemption of stock Is “not essentially equivalent to a dividend” within the meaning of sec. 302(b)(1), the fact that it fails to be “substantially disproportionate,” within the purview of sec. 302(b) (2), “shall not be taken into account.” It is to be noted that the term “substantially disproportionate” had acquired a fixed and definite meaning as a term of art long before its incorporation into the 1954 Code, see Genevra Reman, 32 T.C. 479, 283 F. 2d 227 (C.A. 8, 1960). Although redemptions were ultimately to qualify for capital gains treatment in accordance with three definite standards in addition to the more vague “not essentially equivalent” standard under the Senate version, the Rouse version of see. 302 would have limited capital gains treatment only to those redemptions which were “substantially disproportionate.” Thus the House report stated that “a distribution will be treated as a distribution in payment in exchange for stock only if the distribution is ‘substantially disproportionate.’ ” H. Rept. No. 1337, 83d Cong., 2d Sess., p. a73 (1954). That the House understood it was dealing with a term of art — one which had acquired a specific meaning — is indicated by its use of quotes to set off the words “substantially disproportionate.” However, since the House planned to make “substantial disproportion” the only test of dividend equivalency, it desired to give that term a stricter meaning than had hithertofore been given it by the courts. Thus, the House provided that “a distribution will be considered to be substantially disproportionate, with respect to a shareholder only if, immediately after the redemption, such shareholder owns less than 80 percent of the percentage of stock held by him prior to the distribution.” H. Rept. No. 1337, supra. While It cannot be doubted that the quantitative meaning of the term “substantially disproportionate” 'was thus henceforward to be different, there Is nothing which Indicates that Its qualitative meaning as a term of art was to be changed In any way from that which It had under existing, i.e., 1939 Code, law. A reasonable conclusion to be drawn from this analysis is that “substantially disproportionate,” which was utilized under the 1939 Code as one of the criteria in determining “nonessential dividend equivalency,” and “substantially disproportionate” as used in section 302(b) (2) are differentiated in meaning only by extent, and in every other sense have the same meaning. The Injunction of section 302(b)(5) would therefore remove from the 302(b)(1) Inquiry all consideration as to whether the redemption under scrutiny was “substantially disproportionate” In any sense.    “Not material,” meaning that a redemption should not be considered “not essentially equivalent to a dividend” merely because of the absence of corporate earnings and profits. Dividend treatment of the distribution in such a case would result merely in a reduction in basis at which the stock is held. See secs. 302(d) and 301(c)(2).    “The net effect of the distribution rather than the motives and plans of the taxpayer or his corporation is the fundamental question” in determining dividend equivalency. Flanagan v. Commissioner, 118 F. 2d 937 (C.A.D.C. 1940). “under this test, the court must hypothesize a situation where the corporation did not redeem any stock, but instead declared a dividend for the same amount. The court then must examine the situation after the dividend and compare it with the actual facts of the case when stock was redeemed, viewed always from the shareholders’ vantage point. The redemption Is equivalent to a dividend if the results from the hypothetical dividend and the actual stock redemption are essentially the same.” Ballenger v. United States, 302 F. 2d 192, 196 (C.A. 4, 1962). Under the strict “net effect” test, evidence as to business purpose is not permitted.    See also A. B. Levit, 43 B.T.A. 1077, 1084 (1941), where, after stating that a number of tests had been evolved by the courts for determining the dividend equivalency of redemptions, we said that “one of the tests which is more favored Is whether the redemption was apparently dictated by the reasonable needs of the business or whether, on* the •other hand, It originated with or was designed for the benefit of the stockholders who received its fruits [citing cases]. It is true that most, if not all, of the caseB applying that test have found other circumstances as well to support the result. But essentially toe think the test applicable by its oten weight and that if applied it will be decisive 0/ the present controversy(Emphasis supplied.)    In answer to the Question, “Why did Boogaart Supply Company, Inc., want to acquire these [four grocery] stores?” J. Milton Sorem testified as follows: “Well, we had been advised by our auditing firm and also an underwriter we were working with that we should make an effort to consolidate all of our corporations under the parent company, Boogaart Supply Company, Inc., because our financial statement was such that it looked to them that we would have to raise this money through equity capital Instead of Increasing our debt, namely, possibility of going public with our stock, so we were Interested In getting all of the * * * subsidiaries wholly owned by the parent company, Boogaart Supply Company, Inc., to bolster up our financial statement. The important thing, that is, that toe felt, anyway, was to get the earnings of these four retail stores over into the parent company, because in borrowing money the financial institutions, the banks, and so forth, looked to your ability to pay these obligations even more than some of the assets that you have, and it was real important in onr opinion to get the earnings of four good retail stores over into the parent company so that those earnings could be listed or consolidated with the parent company’s report.” (Emphasis supplied.)