*1 UNITED STATES v. DAVIS et ux. No. 282. Argued January 12, 1970 Decided March 23, 1970 *2 for cause argued Griswold General Solicitor Assistant were brief on him With States. Wil- Zinn, and J. Walters, Matthew General Attorney Goldman. L. liam respondents. for cause argued Waller William McCullough. G. Robert was brief on him
With opinion delivered Marshall Justice Mr.
Court. cor- 1 Bradley organized B.E. taxpayer In transferred property for exchange poration. common shares received Bradley company, new received similarly each wife his taxpayer stock, and an made taxpayer thereafter, Shortly shares. such purchasing corporation, contribution additional per $25 value par aat stock preferred shares 1,000 share. increase towas transaction latter qualify thereby capital working company’s Recon- through negotiated previously loan understood It Corporation. Einancе struction when preferred redeem P. Davis. Maclín are to “taxpayer” opinion in this References year filed were returns joint solely because party aiswife His question. the RFC loan had been repaid. Although in the interim taxpayer bought Bradley’s 500 shares and divided them between his son and daughter, the total capitalization of the company remained the same until 1963. That year, after the loan was fully rеpaid and in accordance with the original understanding, the company redeemed taxpayer’s preferred stock.
In his
personal
income tax return taxpayer did
not report the $25,000 received by him upon the redemp-
tion of his preferred stock as income. Rather,
considered the redemption as a sale of his preferred stock
*3
to the company
capital gains
—a
transaction under § 302
of the Internal Revenue Code of 1954 resulting in no
tax since taxpayer’s
in
basis
the stock equaled the amount
he received for it. The Commissioner of Internal Rev-
enue, however, did not approve this tax treatment. Ac-
cording to the Commissioner,
the redemption of tax-
payer’s stock was essentially equivalent
to a dividend
and was thus taxable as ordinary income under §§301
and 316 of the Codе. Taxpayer paid the resulting defi-
ciency and brought
this suit for a refund. The District
Court ruled in his favor,
2 Only the Second Circuit has unequivocally adopted the Com
missioner’s view and held irrelevant
the motivation of the redemp
tion. See Levin v. Commissioner,
in We corporations. held closely by redemptions reverse. I generally provides Code Revenue Internal The of distributions treatment §§ pro- those under shareholders; its to by a gross taxpayer’s ain includable is distribution visions, profits earnings and out dividend aas income exceptions are There exist.3 earnings such extent however, provisions, general these apрlication certain involving 302§in found those are them among question basic The stock. redeemed distributions cor- distribution $25,000 whether case section —more under falls poration motivation legitimate its whether specifically, 302§ distribution qualifies however, Circuit, First States, 343 Compare conclusion, too. come almost seems Bradbury (1967), with 2d F. v. United Wiseman *4 (1962). 111 2dF. Commissioner, 298 v. are question that, on passed have appeals courts other (b)(1) weight some least give willing to apparently See, redemption. distribution a motivation business 10th Cir. (C. A. 337 2dF. Berenbaum, 369 v. g., Commissioner e. 1964); Cir. 9thA. (C. 225 2dF. Commissioner, 326 v. 1966); Kerr 1962); Cir. 4thA. (C. 192 2dF. States, 301 United Ballenger v. 1960); Cir. 8thA. (C. 227 2d F. Commissioner, 283 v. Heman 1958). See Cir. 5th (C. A. 496 2d Fewell, F. 255 v. States United (1962). 322, 305 Cl. Ct. v. United also Neff however, purpose, business consider courts among those Even related, not required generally it See it. stock, but issuance States, Ballenger v. supra; Berenbaum, v. Commissioner
supra. 83, 88-89 U. S. Gordon, 391 g., Commissioner e. See, did contention makes Taxpayer profits. earnings accumulated $25,000
Preliminarily, however, we must consider the relation- ship between §302 and the rules regarding attribution of stock ownership found in § (a) of the
Under subsection (a) of § 302, a distribution is treated as “payment in exchange for the stock,” thus qualifying for capital gains rather than ordinary income treatment, if the conditions contаined in any one of the four para- graphs of subsection (b) are met. In addition to para- graph (l)’s “not essentially equivalent to a dividend” test, capital gains treatment is available where (2) the taxpayer’s voting strength is substantially diminished, (3) his interest in the company is completely terminated, or (4) certain railroad stock is redeemed. Paragraph (4) is not involved here, and taxpayer admits that parа- graphs (2) and (3) do not apply. Moreover, taxpayer agrees that for the purposes of §§ 302 (b)(2) and (3) the attribution rules of § 318 (a) apply and he is con- sidered to own the 750 outstanding shares of common stock held by his wife and children in addition to the 250 shares in his own name.4 Taxpayer, however, argues that the attribution rules do not apply in considering whether a distribution is essentially to a dividend under § 302 (b)(1). 4 Section (a) provides in part relevant as follows: “General rule. —For purposes of provisions those of this sub- chapter to which the rules contained in this section are expressly made applicable—
“(1) Members of family.—
“(A) In general.—An individual shall be considered as owning the stock owned, directly or indirectly, by or for—
“(i) his spouse (other than a spouse who is legally separated from *5 the individual under a decree of divorce separate or maintenance), and “ (ii) his children, grandchildren, parents.” and In (b) 318§ the rales contained in (a) subsection are made specifi- cally applicable to “section 302 (relating to redemption of stock).” 306 considered be thus should he taxpayer, to
According common corporation’s the of percent 25 only own to under qualify then would distribution the and stock, proportionate rata pro was it since (b)(1) 302 § dividend of test fundamental the interest, stock his to However, (b). 1.302-2 Reg. Treas. See equivalency. of rejection compels statute the of language plain the attribu the 302, §of (c) subsection argument. determining “in applicable specifically made are rules tion section.” this of purposes stock of ownership that held below courts both language, this Applying (b)(1)— 302§ including 302, §of all aрplies (a) 318§ of courts other of the decisions with accord a view and regulation,6 treasury longstanding appeals,5 commentators.7 leading opinion that argues authority, weight Against be- different be should (1) paragraph result ownership reference explicit no there cause fact, Neither (3). (2) paragraphs inis as there 302§of history purpose nor however, rules— attribution argument. taxpayer’s support other- what answer clear provide designed part question a difficult —formed wise 1954 as enacted subsequently was bill passed as bill infra, further, discussed isAs com- provision no contained Representatives House added was provision When (b) 302§to parable restrict evidenced Senate, rules attribution (a). 318§of applicability 2d (C. A. 521, 526-527 F. 2d Commissioner, 385 v. Levin See (C. A. 337, 342 2dF. Berenbaum, 369 1967); Commissioner Cir. 192, 2d F. Ballenger v. 1966); Cir. 10th Commissioner, 298 Bradbury v. 1962); Cir. A. 4th (C. 1962). Cir. 1st (C. A. 116-117 (b). Reg. 1.302-2 Treas. See Cor Taxation Income Eustice, Federal J.& Bittker B. See 1966). (2d ed. 292 n. Shareholders porations *6 continued to be made specifically applicable to the entire section, and we believe that Congress intended that they be taken into account wherever ownership of stock was relevant. Indeed, it was necessary the attribution rules
apply to §302 (b)(1) unless they were to be effec- tively eliminated from consideration with regard to §§ 302 (b)(2) and (3) also. For if a transaction failed to qualify under one of those sections solely because of the attribution rules, it would according to taxpayer’s argument nonetheless qualify under §302 (b)(1). We cannot agree that Congress intended so to nullify its explicit directive. We conclude, therefore, attribution rules of § 318 (a) do apply; and, for the purposes of deciding whether a distribution is "not essen- tially equivalent to a dividend” under § 302 (b)(1), taxpayer must be deemed the owner of all 1,000 shares of the company’s common stock.
II After application of the stock ownership attribution rules, this case viewed most simply involves a sole stock holder who part causes of his shares to be redeemed by the corporation. We conclude that such a redemption is always “essentially equivalent to a dividend” within the meaning of that phrase in § 302 (b)(1) and there fore do not reach the Government’s alternative argument in any event the distribution should not on the facts of this case qualify for capital gains treatment.9 8 Of course, just means that a distribution in redemption to a sole shareholder will be treated under the general provisions of 301, § and it will only be taxed as a dividend under 316 to § the extent that there are earnings profits. 9The Government argues that even if business purpose were relevant under (b)(1), the business purpose present here related only to the original investment and not at all to the necessity *7 tax the into came of predecessor Stat. 1921, of Act Revenue the (d) 201§as law 228: if but to subject be not shall dividend stock “A cor- dividend such any distribution after stock its redeem or cancel to proceeds poration dis- make toas manner such in time such essentially redemption or cancellation tribution dividend, taxable aof distribution to cancellation or redemption in received amount ... dividend taxable aas treated be shall stock rata pro decision Court’s this to response in Enacted Eisner income, taxable constitute not do dividends stock had provision (1920), S.U. Macomber, 252 from a preventing obvious earn- distributing treatment dividend avoiding rata pro transactions —a two in shareholders its to ings redemption rata —that pro by a followed dividend stock simple aas consequences economic same have would even recognized soon however, Congress, dividend. result same essentially dividend stock prior a without “especially corporation, any whereby effected be could able might stockholders, few only a has which one which stockholders its distribution make Rep. R.H. dividend.” taxable aas effect same cover order Sess., 5. 1st Cong., 69th 1, No. “(whether apply amended law w:as situation, whenever dividend)” stock as a issued was stock such not such “at made was in distribution equiv- essentially that'it manner” such time view, either Under supra. 2, n. cited, cases See redemрtion. Under stock. preferred basis his lose does common taxpayer's apphed basis 1,302-2 (c) Reg. Treas.
stock.
alent to a taxable dividend. Revenue Act of § 201 (g), 44 Stat. 11.
This provision of the 1926 Act was carried forward
in each subsequent
revenue act and finally became
§ 115 (g)(1) of the Internal Revenue Code of 1939. Un-
fortunately, however,
policies
encompassed within the
general
language of §115 (g)(1)
and its predecessors
were not clear, and there resulted much confusion in
the tax law. At first, courts assumed that the provision
*8
was aimed at tax avoidance schemes and sought only to
determine whether such a scheme existed. See, e. g.,
Commissioner v. Quackenbos,
By the time of the general revision resulting in the
Internal Revenue Code of 1954, the draftsmen were faced
with what has aptly been described as “the morass
created by the decisions.” Ballenger v. United States,
“The test intended to be incorporatеd in the in- terpretation of paragraph (1) is in general that cur- rently employed under section 115 (g)(1) of the 1939 Code. Your committee further intends that in ap- plying this test for the future . . . the inquiry will be devoted solely to the question of whether or not the transaction by its nature may properly be char- acterized as a sale of stock by the redeeming share- holder to the corporation. For this purpose thе presence or absence of earnings and profits of the corporation is not material. Example: X, the sole shareholder of a corporation having no earnings or profits causes the corporation to redeem half of its stock. Paragraph (1) does not apply to such re- demption notwithstanding the absence of earnings profits.” S. Rep. No. 1622, supra, at 234. The intended sсope of § 302 (b)(1) as revealed by this legislative history is certainly not free from doubt. How- ever, we agree with the Government making sole inquiry relevant for the future the narrow one whether the redemption could be characterized as a sale, Congress was apparently rejecting past court decisions that had also considered factors indicating the presence or absence оf a tax-avoidance motive.11 At least that is *10 10See Bittker & Eustice, supra, 7,n. at 291: “It is easy not give 302 (b) (1) § an expansive construction in view of this indication that its major function was the narrow one of immunizing redemp- tions of minority holdings of preferred stock.” rejection This is by confirmed the Committee’s acceptance of the House treatment of distributions involving corporate contrac tions —a present factor in mаny of the earlier “business purpose” clearly- Congress given. example the implication the the under treated be distributions rata pro that mandated than rather and §§301 in down laid rules general a be should there that suggests nothing 302, § under the for purpose” “business awere if there result different be must inference opposite the just Indeed, redemption. tax-avoidance abe likely not would there since drawn оr earnings were there where situation ain purpose was Appeals Court the conclude We profits. con- purpose business looking in wrong therefore equiv- the whether deciding init sidering Court the with agree we dividend. ato alent “the Circuit Second Appeals determining in irrelevant is transaction of a Hasbrook (b)(1). 302§ equivalence” dividend 811, 814 redemp- treat argues strongly Taxpayer dividend ato essentially as here involved tion Thus, substance. over form elevate he had shares Bradley's bought not he had argues, instead company loan a subordinated made his back gotten could he stock, preferred buying However, treatment. favorable with $25,000 law in substance form between difference as stated Committee action, describing its redemptions. follows: their into separates bill, House did committee, as “Your аggre- incoherently now of transactions kind elements significant distribu- Those liquidation. partial aof definition gated they are became characteristics capital-gain may have which tions be sub- would shareholders various among the rata pro made described tests separate level, to shareholder at jected, character- distributions hand, those other On the 318]. [§§ reason level corрorate solely happens by what ized concept of within as included distributed assets (Emphasis 49. supra, at No. Rep. S. liquidation.” partial added.)
is largely problematical, and taxpayer’s complaints have little to do with whether a business purpose is relevant under § 302 (b)(1). It was clearly proper for Congress to treat distributions generally as taxable dividends when made out of earnings and profits and then to prevent avoidance of that result without regard to motivation where the distribution is in exchange for redeemed stock.
We conclude that is what Congress did when enacting § 302 (b)(1). If a corporation distributes prop- erty as a simple dividend, the effect is to transfer the property from the company to its shareholders without a change in the relative economic interests or rights of the stockholders. Whеre a redemption has that same effect, it cannot be said to have satisfied the “not essen- tially equivalent to a dividend” requirement of § 302 (b)(1). to qualify for preferred treatment under that section, a redemption must result in a mean- ingful reduction of the shareholder’s proportionate in- terest in the corporation. Clearly, taxpayer here, who (after application of the attribution rules) was the sole shareholder of the corporation both before and after the redemption, did not qualify under this test. The deci- sion of the Court of Appeals must therefore be reversed and the case remanded to the District Court for dis- missal of the complaint.
It is so ordered. Me. Justice Douglas, with whom The Chief Jus- tice and Mr. Justice Brennan concur, dissenting.
I agree with the District Court,