DocketNumber: Docket No. 1727-74
Citation Numbers: 1976 U.S. Tax Ct. LEXIS 4, 67 T.C. 522
Judges: Drennen
Filed Date: 12/22/1976
Status: Precedential
Modified Date: 1/13/2023
Petitioners, as stockholders of Associates, the parent corporation of an affiliated group, received distributions from Associates during the year 1971 with respect to their stock. The basic issue is whether the entire amount of the distributions was taxable to petitioners as ordinary dividends or whether a part thereof was nontaxable as a return of capital. Determination of the basic issue requires determination of several subsidiary issues involving the effect on the earnings and profits of Associates and its subsidiaries of various transactions that occurred during the computation years.
1.
2. Corporations which subsequently became subsidiaries of Associates issued qualified stock options for their stock to their employees. Upon *5 the merger and reorganization of those corporations with Associates becoming the parent corporation, Associates assumed the stock options within the meaning of sec. 425(a) of the Code and Associates' stock became subject to the options. Thereafter qualified stock options with respect to Associates' stock were issued to employees of the subsidiaries and dual employees of both Associates and the subsidiaries. The employees exercised some of the options during the computation years. Assuming that the spread between the option price and the fair market value of the option stock on the date of exercise is a proper charge to earnings and profits, see
3.
*523 OPINION
Respondent determined a deficiency in petitioners' income tax for the calendar year 1971 in the amount of $ 539.83. The ultimate issue for our decision is the extent, if any, to which corporate distributions received by petitioners with respect to their stock in the distributing corporation constituted dividends to them taxable in the year of receipt as ordinary income. This ultimate *7 issue depends upon the extent that such distributions were made out of the distributing corporation's earnings and profits and this determination depends principally upon a resolution of the following issues: 1
(1) What is the correct method for determining the proper charge to a corporation's capital account under
*524 (2) On the assumption that the exercise of a stock option issued pursuant to section 422 generates a reduction in corporate earnings and profits by the difference between the fair market value of the stock at the date of exercise and the option price, which corporation is entitled to this reduction, the issuing corporation or the employer corporation, when a parent issues the stock to employees of its subsidiary; and
(3) When a corporation begins a taxable year with no accumulated earnings and profits but generates earnings and profits during said year and makes two categories of distributions to its shareholders during the year, ordinary cash distributions and a
This case was submitted fully stipulated pursuant to
Petitioners Ronald D. Anderson and Marilyn J. Anderson (hereinafter referred to as petitioners), husband and wife, resided at Wauwatosa, Wis., when they filed their 1971 joint income tax return (Form 1040), as well as when they filed the petition herein.
Petitioners filed their joint Federal income tax return for the year 1971 with the Midwest Service Center of the Internal Revenue Service at Kansas City, Mo.
American Appraisal Associates, Inc. (hereinafter referred to as Associates), is a Delaware corporation with its principal offices at Milwaukee, *9 Wis. Associates files its corporate income tax returns on the basis of a fiscal year ending March 31. Associates had one class of stock, common stock, which is traded over the counter. The number of Associates' shareholders and the approximate number of its outstanding shares of common stock as of March 31, 1970, 1971, and 1972, are as follows: *525
Shares | ||
FYE Mar. 31 -- | Shareholders | outstanding |
1970 | 299 | 114,160 |
1971 | 322 | 113,240 |
3 1972 | 1,052 | 1,810,000 |
As of January 1, 1971, petitioners owned individually or jointly 250 shares of Associates' common stock, which increased to 3,750 shares after the 15-for-1 split on April 28, 1971. Petitioners acquired no additional shares of Associates during 1971 and, on June 21, 1971, they sold 700 of their shares. During 1971, petitioners received the following cash distributions from Associates with respect to the shares owned by them on the indicated payment dates:
Payment date | Amount |
Feb. 9, 1971 | $ 437.51 |
Apr. 13, 1971 | 499.99 |
July 30, 1971 | 320.25 |
Nov. 10, 1971 | 320.25 |
1,578.00 |
On each of the above-described payment *10 dates, the adjusted basis of the petitioners in each of their shares of Associates' stock exceeded the amount of the distribution made to them on such date with respect to such share.
On their 1971 income tax return, petitioners reported the above-described distributions as follows:
Reported as | ||
taxable dividend | Reported as | |
(before sec. 116 | nontaxable | |
Payment date | exclusion) | distribution |
Feb. 9, 1971 | -- (0%) | $ 437.51 (100%) |
Apr. 13, 1971 | $ 4.99 (1%) | 495.00 (99%) |
July 30, 1971 | 3.20 (1%) | 317.05 (99%) |
Nov. 10, 1971 | 3.20 (1%) | 317.05 (99%) |
1 11.39 | 2 1,566.61 |
This manner of reporting the distributions was based on advice received by petitioners from Associates that (a) no portion of the distribution made by Associates to its shareholders on February 9, 1971, constituted a distribution out of *526 Associates' current or accumulated earnings and profits within the meaning of
Respondent, in his notice of deficiency *11 dated February 13, 1974, determined that all of the $ 1,578 in distributions received by petitioners from Associates in 1971 should have been reported as taxable dividends; accordingly, respondent increased petitioners' taxable income by $ 1,378 (the amount of the distributions minus the $ 200 exclusion permitted by section 116), resulting in an income tax deficiency of $ 539.83. This adjustment was based on respondent's position that the entire amount of the distributions received by petitioners from Associates in 1971 constituted distributions out of Associates' current or accumulated earnings and profits within the meaning of
The sole issue we must decide is what portion of the cash distributions made by Associates to petitioners during the calendar year 1971 was taxable as dividends to them. However, to reach this decision it is necessary to first determine the effect on the earnings and profits of Associates and several of its subsidiaries of various transactions occurring during the applicable years.
The statutory phrase "earnings and profits" is nowhere defined in the Code and a shorthand explanation thereof is difficult. 7 For purposes of this discussion, earnings and profits may be thought of as a tax accounting concept utilized to determine the tax consequences of corporate distributions to shareholders.
Associates was organized on February 25, 1970, and became active as of April 1, 1970; at that date Associates had no earnings and profits.
*528 On April 1, 1970, Associates acquired, in tax-free reorganizations, the American Appraisal Co. and Cole-Layer-Trumble Co. The acquisition of the American Appraisal Co. (Old TAACO) was accomplished by a merger of that corporation into *15 Associates and a transfer by Associates of all the merging corporation's assets into a new subsidiary, the American Appraisal Co., Inc. (New TAACO). This acquisition constituted a tax-free reorganization within the meaning of sections 368(a)(1)(A) and 368(a)(2)(C). The acquisition of Cole-Layer-Trumble Co. (CLT) was accomplished by a tax-free exchange of shares of Associates for all the outstanding shares of the acquired corporation; the acquisition constituted a tax-free reorganization within the meaning of section 368(a)(1)(B). At the time of its acquisition by Associates, Old TAACO owned all of the outstanding shares of Standard Research Consultants, Inc. (SRC). These shares were acquired by Associates and distributed to New TAACO pursuant to the April 1, 1970, reorganization and, throughout the taxable years involved in this case, SRC continued as a wholly owned subsidiary of New TAACO. On November 2, 1970, Associates acquired all of the outstanding shares of Stone & Youngberg Municipal Financing Consultants, Inc. (S. & Y.). None of these acquisitions resulted in any of the earnings and profits of the acquired corporations being deemed received or retained by Associates.
As *16 noted previously, during the fiscal years ending March 31, 1971, and March 31, 1972, Associates, New TAACO, CLT, SRC, and S. & Y. constituted an "affiliated group" of corporations as defined under section 1504(a). And as permitted by section 1501, Associates, as common parent, filed consolidated tax returns on behalf of said group for each of those taxable years. During the computation years, Associates received cash distributions from CLT, New TAACO, and S. & Y. These distributions are significant herein and are the source of the added complexity in computing Associates' earnings and profits.
The logical approach to follow in making these determinations is to focus upon CLT, New TAACO, and S. & Y., individually, and determine the status of the distributions made by each for both of the computation years. Indeed, this is the manner in which the computation under Rule 155 will proceed; however, a sequential analysis herein of the relevant facts and legal issues is not possible.
The legal issue we must first decide is what portion of a redemption distribution, described in
(a)
(i) 2,500 shares of $ 1 par value class A common stock ($ 2,500) with paid-in capital of $ 16,704 attributable thereto.
(ii) 7,500 shares of $ 1 par value class B common stock ($ 7,500) with paid-in capital of $ 50,110 attributable thereto.
(iii) 1,710 shares of $ 100 par value preferred stock ($ 171,000) with no paid-in capital attributable thereto.
*531
On December 15, 1968, 11*23 CLT distributed $ 510,000 to one of its shareholders in redemption of 425 shares of class A common stock and 1,275 shares of class B common stock. CLT treated this distribution as one which came within the general rule of
(e) Special Rule for Partial Liquidations and Certain Redemptions. -- In the case of amounts distributed in partial liquidation (whether before, on, or after June 22, 1954) or in a redemption to which
Neither the meaning of "capital account" nor the procedure for determining what part of a distribution is "properly chargeable" thereto is included in the Code or the regulations.
CLT applied
The 1,700 shares redeemed (425 class A shares and 1,275 class B shares) represented 17 percent of the outstanding common stock. CLT debited its corporate books accordingly:
Stated capital -- class A common | $ 425 | (17% of $ 2,500) |
Stated capital -- class B common | 1,275 | (17% of $ 7,500) |
Paid-in capital | 11,358 | (17% of $ 66,814) |
Retained earnings | 496,941 | |
Total charge | 510,000 | (rounded) |
For *25 tax purposes, CLT accounted for the transaction in the same manner, i.e., CLT treated the term "capital account" as meaning total capital contributed by the shareholders with respect to the class(es) of stock redeemed. CLT determined *533 that the proper charge to capital under
Petitioners contend that the above procedure used by CLT was in accordance with the interpretation given to
Respondent contends that the interpretation of
What is now
In the case of amounts distributed in partial liquidation 17 * * * the part of such distribution which is properly chargeable to capital account *28 shall not be considered a distribution of earnings or profits * * * for the purpose of determining the taxability of subsequent distributions by the corporation.
Neither the definition of the term "capital account" nor the manner in which to make the "proper charge" thereto was contained in the Act of 1924. The legislative comments contained in the committee reports which accompanied this legislation were sparse. Both the House and Senate reports contained the same statement with respect to the provision which is now
No similar provision is contained in the existing law, although the provisions of the bill represent what is probably a correct construction of existing law and unquestionably what is in accord with business practice. [H.Rept. No. 179, 68th Cong., 1st Sess. 11-12 (1924); S. Rept. No. 398, 68th Cong., 1st Sess. 11-12 (1924).]
Upon examination of the "existing law" and the contemporary "business practice," the legislative comment proves to be less than enlightening. 18 No more enlightening is *29 the example contained in the "Statement of the Changes Made in the Revenue Act of 1921 by H.R. 6715 and the Reasons Therefor," 68th Cong., 1st Sess. 3 (Comm. Print 1924), to illustrate the effect of this section, which merely demonstrates that payment of par value in redemption of stock "constitutes a capital transaction and does not affect the earnings and profits of the corporation on hand for subsequent distribution."
*535 The meaning of the term "capital account" was first alluded to in the case of
We think that a proportional part of the paid-in capital must be considered as standing behind each of the shares outstanding *30 at any particular time, so that on redemption of any of them a certain part of the redemption is properly chargeable against capital account. * * * [
Next, in
The Commissioner issued a nonacquiescence to the
*536 From the time of its enactment, section 201(c),
In 1954 the Internal Revenue Code underwent review which resulted in substantial amendments thereto and included among the changes *32 was a comprehensive revision of subchapter C, "Corporate Distributions and Adjustments." As part of the revision to subchapter C the bill introduced by the House of Representatives (H.R. 8300) contained a new provision, sec. 310(c), which, in pertinent part, stated:
(c) Partial Liquidations, Corporate Separations, and Redemptions. -- * * * upon a redemption of stock * * * which is treated as a distribution in full or part payment for such stock under
In rejecting this proposed new rule the Senate Finance Committee responded:
The House bill supplied an additional rule for the determination of the manner in which earnings and profits should be allocated when there was a * * * redemption. Your committee strikes this rule since it is believed that existing administrative practice, *33 making these determinations as the facts of each case may indicate, has been successful in achieving correct results. [S. Rept. No. 1622, 83d Cong., 2d Sess. 47 (1954).]
*537 In 1970 the Treasury adopted a change in the administrative *34 practice respecting
In 1972, in the case of
On brief in the case now before the Court, respondent asks us to reconsider our decision in
Rather than engaging in a lengthy and, we believe, fruitless discussion of the relative merits and criticisms of the respective formulas for the application of
Respondent's brief in this case is essentially an amplification of the justification given in
In place of
However, as has been pointed out elsewhere, 23 by means of simple algebra *39 this formula breaks down into the following components: Proper charge to capital = amount distributed - [(shares redeemed / total shares outstanding) x earnings and profits].
Consequently, under respondent's formula the redeemed shares' pro rata portion of earnings and profits is first determined and subtracted from the amount of the distribution and the remainder of the distribution is the "proper charge to capital account." We believe that this formula is contrary to the statutory language which requires computation of the charge to capital first
To be sure, under some circumstances the formula pronounced in
In our examination of the writings on this subject we note that the authorities have criticized both the
The
(b)
On March 16, 1970, CLT distributed $ 411,733 to one of its shareholders in redemption of all 1,710 shares of its outstanding preferred stock. At the time of the redemption there were no accrued unpaid dividends with respect to said stock.
For tax purposes CLT treated this redemption as it had the previous year's common stock redemption: It charged $ 171,000 to its capital account under
*542 For the reasons stated above in our discussion of the effect *45 of the redemption of the common stock on CLT's earnings and profits, we conclude that CLT's treatment of the amount paid to redeem all of its preferred stock outstanding was in accord with the formula prescribed in the
In addition to arguing the propriety of applying the
We reject respondent's proposed treatment. While a strict reading of our holding in
We think that a proportional part of the paid-in capital must be considered as standing behind each of the shares outstanding at any particular time, so that on redemption of any of them a certain part of the redemption is properly chargeable against capital account. * * * [
*543 Consequently, if the paid-in capital of a corporation is clearly attributable to specifically distinguishable classes of stock, the proper charge to "capital account" should *47 be made to the capital account which represents the class of stock being redeemed. 29*48 By making this determination herein we do not mean to state a hard and fast rule in this regard for under different circumstances it may be appropriate to make the computation otherwise; for example, if through various means the corporate structure has been reshaped in such a manner as to make it impossible to account for the capital attributable to specific classes of stock. But for purposes of this case we hold that under
On this issue we conclude that CLT's computation of the amounts chargeable against its earnings and profits as a result of the redemption of both its common stock in 1969 and its preferred stock in 1970 was correct.
The next issue for our consideration involves a rather controversial topic, the effect on corporate earnings and profits resulting from the grant and exercise of employee stock options.
Sometime prior to April 1, 1970, the date Associates acquired the subsidiary corporations herein, both Old TAACO and CLT had issued certain "qualified stock options" (as defined in section 422) to employees. Old TAACO had granted options to purchase its common stock to some of its own employees and to one employee of its wholly owned subsidiary, SRC. CLT had granted options to purchase its common stock to some of its employees.
*544 As part of the April 1, 1970, acquisitions by Associates of Old TAACO and CLT, the above-described stock options were assumed by Associates within the meaning of section 425(a); thereafter, such options pertained to shares of Associates' common stock.
After April 1, 1970, *49 all of the former employees of Old TAACO who had been granted options by that corporation became employees of New TAACO; three of these individuals, who had been senior officers of Old TAACO, became officers of both Associates and New TAACO (hereinafter referred to as dual employees). The SRC employee who had received an option to purchase Old TAACO shares remained solely in the employ of SRC after April 1, 1970.
The employees of CLT who had received the stock options from that corporation remained CLT employees after the April 1, 1970, acquisition. However, after Associates' acquisition one of said employees who had been a senior officer of CLT also became an officer of Associates; he will also be referred to hereafter as a dual employee.
Subsequent to the April 1, 1970, acquisition, Associates granted additional qualified stock options to purchase its common stock to the dual employees as well as to certain employees of New TAACO, CLT, SRC, and S. & Y.
During the taxable years ended March 31, 1971, and 1972, the dual employees and the employees of New TAACO, CLT, SRC, and S. & Y. exercised some of the qualified options. The employer of the optionees, the fair market value of Associates' *50 stock at date of exercise, and the price paid to exercise said options are stipulated as follows:
Employer of optionees | FMV at date | Option |
exercising options | of exercise | price paid |
TYE Mar. 31, 1971 | ||
Dual employees | $ 15,000 | $ 6,874 |
New TAACO | 110,250 | 50,524 |
CLT | 238,500 | 109,472 |
SRC | 7,500 | 3,437 |
371,250 | 170,307 | |
TYE Mar. 31, 1972 | ||
Dual employees | $ 112,088 | $ 54,864 |
New TAACO | 325,457 | 92,247 |
CLT | 297,017 | 68,751 |
SRC | 19,881 | 4,770 |
S. & Y. | 12,450 | 7,998 |
766,893 | 228,630 |
*545 All of the options exercised by the dual employees during the fiscal year ended March 31, 1971, had been granted initially by Old TAACO and assumed by Associates. Some of the options exercised by said dual employees during the fiscal year ended March 31, 1972, likewise had been granted by Old TAACO and later assumed by Associates; the remainder had been granted by New TAACO (as stipulated) after April 1, 1970.
During the taxable years ended March 31, 1971, and March 31, 1972, all of the optionees who exercised the options received their compensation from either New TAACO or CLT. New TAACO paid the compensation of the following employees: (1) Dual employees of New TAACO and Associates; (2) New TAACO officers; and (3) SRC officers. 30CLT paid the compensation of the CLT*51 officers and the dual employee of CLT and Associates. Both New TAACO and CLT claimed the amounts of compensation paid to the above-described individuals as deductions on the respective consolidated tax returns.
The issue now under discussion is substantially circumscribed as a result of a concession by respondent. Respondent concedes that upon the exercise of a qualified employee stock option an amount equal to the spread between the fair market value of stock at the date of exercise and the option price paid therefor is a proper reduction to earnings and profits. Respondent concedes this issue only for purposes of this case and only because of the position taken by the Seventh Circuit Court of Appeals, to which an appeal of this case would lie, in
However, a controversy remains because respondent asserts that the corporation which is entitled to reduce its earnings and profits in a case such as this is the corporation that
The parties have stipulated that all of the stock options with which we are concerned were "qualified stock options" as defined under section 422 and that the options which were issued prior to April 1, 1970, were assumed by Associates in accordance with section 425(a).
On appeal of the
Since the
Under the
* * * (2) no deduction under section 162 (relating to trade or business expenses) shall be allowable at any time to the employer corporation, a parent or subsidiary corporation of such corporation, or a corporation issuing or assuming a stock option in a transaction to which section 425(a) applies, with respect to the share so transferred; * * *
The language used in
We believe it follows that were it not for
(a) The parent is deemed to have transferred to the subsidiary-employer an amount of cash equal to the spread between the option price and fair market value of the stock at the date of exercise. This cash represents a contribution of capital by the parent *58 and permits an increase in its basis in the subsidiary's stock.
(b) The subsidiary is deemed to purchase the parent's stock needed to distribute to the employees with the cash received *549 from the parent plus its own funds in an amount equal to the option price. As a result of the transaction the parent has realized no income, sec. 1032, and the subsidiary has a basis in the parent's stock equal to its fair market value (the purchase price).
(c) The subsidiary is deemed to transfer the parent stock to its employees in return for services plus the option price. Were it not for
While the
Petitioners disagree on several grounds. They first cite
Petitioners also argue that "it is the clear purpose of the cited Code provisions [secs. 422(b) and 421(a)] to treat Associates in all respects as if it were the 'employer' corporation." Relying on
Petitioners do not elucidate on how they arrive at this conclusion. Perhaps it is because
The legislative history of section 218 of the Revenue Act of 1950, which added new section 130A to the Code, the precursor of
We conclude that the reduction in earnings and profits allowed by the Seventh Circuit in
It is stipulated that three optionee-employees of New TAACO, while retaining that employee status, became officers of Associates as well, after April 1, 1970. 35*66 Respondent addresses this question on brief and contends that the corporation for which such dual employees rendered their services more directly is entitled to the reduction in earnings and profits, or alternatively, that each employer be permitted an aliquot reduction of earnings and profits based upon the amount of working time each dual employee spent working for each corporation.
*553 We find that respondent's contentions are in accord with the legal principles enunciated in
We conclude that the corporation which paid the dual employees' compensation is entitled to the appropriate reduction in its earnings and profits.
The final issue for decision is one of first impression in this Court, 37 to wit: What tax treatment is to be accorded ordinary cash distributions received by shareholders when the distributing corporation makes both
*554 On March 31, 1971, Associates repurchased 4,800 of the then-outstanding 118,040 shares of its stock for a price of $ 720,000. The parties have stipulated that the redemption qualified under
We determined in issue 1,
*555 Subchapter C of subtitle A,
Part I contains three subparts: A -- "Effects on recipients," B -- "Effects on corporation," and C -- "Definitions; constructive ownership of stock."
In subpart A our focus is upon pertinent parts of two sections,
Our attention to subpart B, which is concerned with the effects of distributions on corporations, is essentially directed to
Fundamentally the controversy in this case centers upon the proper interpretations to be given
Respondent focuses upon the last-quoted language and interprets the statute as requiring the preservation of all current earnings of the year as a source available for ordinary distributions made during the *76 year so as to categorize them as dividends taxable to recipients pursuant to
Petitioners, to the contrary, contend that application of the relevant Code
After careful consideration of the relevant Code sections and a study of their legislative histories and of the parties' extensive *78 arguments, we resolve this question in favor of respondent and hold that the ordinary cash distributions made by Associates during its taxable year ended March 31, 1971, were out of current earnings and profits to the extent thereof.
Petitioners make essentially three arguments to support their contention that the phrase "any distributions" in
(1) Judicial history of
In 1928 the Supreme Court had occasion to review the statutory definition of a dividend under section 201(a) of the Revenue Act of 1918 (now
In the Revenue Act of 1936, Congress enlarged the definition of a dividend by promulgating new section 115(a)(2) (the current
Petitioners argue that the Supreme Court's holding in
Although petitioners' arguments, on a first reading, have some appeal to logic, an examination of the underpinnings of such reasoning exposes the superficiality of such appeal and we are unpersuaded. Firstly, petitioners' reliance on
Secondly, petitioners' allegation that a misconstruction of the statute results from interpreting the contended phrase "any distributions" to have different meanings in
The term "distribution" has no technical fixed significance under the tax laws; nowhere in the statute is the term defined. We have no doubt that, contrary to petitioners' assertion, a proper application of the rules of statutory construction requires us to interpret this term of plain and general meaning in such a way as to give to it the meaning *561 commonly attributable to it, see
(2) Legislative history of
Prior to the Revenue Act of 1936 a dividend was defined as a distribution out of earnings and profits accumulated since 1913 and distributions were deemed to *85 have been made from the earnings and profits most recently accumulated. In two pre-1936 cases the Supreme Court defined and refined the meaning of accumulated earnings and profits for purposes of the dividend definition. The first,
In the Revenue Act of 1936, Congress introduced a new level of corporate taxation, a surtax on undistributed profits. The purpose of the new tax was to discourage corporations, especially those controlled by taxpayers with large individual incomes, from accumulating surplus profits so as to escape the tax imposed on *86 dividend income. See S. Rept. No. 2156, 74th Cong., 2d Sess. 2 (1936). See also
In order to enable corporations without regard to deficits existing at the beginning of the taxable year to obtain the benefit of the dividends paid credit for the purposes of the undistributed profits surtax, section 115(a) changes the definition of a dividend so as to include distributions out of the earnings or profits of the current taxable year. The amendment simplifies the determination by providing that distributions during the year, not exceeding in amount the current earnings, are dividends constituting taxable income to the shareholder and a dividends paid credit to the corporation. As respects such dividends the complicated determination of accumulated earnings or profits is rendered unnecessary. [S. Rept. No. 2156,
With this legislative history in mind we return to a discussion of the parties' controversy which still centers on the meaning of the phrase "any distributions" as used in
Respondent points to the *88 above-quoted language of the Senate report and contends it is clear that Congress intended the new dividend definition to serve two purposes:
(1) To insure that distributions out of current earnings constituted taxable income to the shareholders in the form of dividends and allow a deficit corporation a credit therefor; and
(2) to obviate the necessity of making the complicated computation involved in determining the existence of accumulated earnings and profits at the time of a distribution.
Respondent notes that the 1936 amendment allowing dividends to be distributed from current earnings and profits did not extend to redemptive distributions; their source remained the same -- the capital account and
*564 Petitioners view the significance of the legislative history of
We reject petitioners' argument. The
*565 Moreover, as pointed out in
Also, we agree with respondent that the clear *92 congressional purpose of eliminating the complicated computation of accumulated earnings and profits when determining a dividend from current year's earnings would be frustrated if redemption distributions were excluded from the scope of the language in
Petitioners, apparently as an alternative argument, urge us not to be concerned with obsolete congressional statements of intent contained in the legislative history of
We believe there is merit to petitioners' contention. We wish to make clear that our conclusion is based upon the entire analysis discussed above. Although we find the intent of Congress
Following the repeal of the undistributed profits tax, 53 since at least 1941, a number of scholars have focused attention on the current earnings test for dividends contained in
(3) Interrelationship of
Petitioners argue that in the case of a
Respondent agrees, as do we, that
*568 The phrase in
Thus, in the preceding example, if the fair market value of property at the time of distribution was $ 150, and the earnings and profits of the distributing corporation, immediately prior to the distribution were $ 120, the amount taxable as a dividend under
However, acceptance of petitioners' interpretation of
But assuming that
Where the corporation making both dividend and redemption distributions in the taxable year had no accumulated earnings and profits at the beginning of the taxable year, we believe the timing rule of
Consequently, we hold that to the extent of Associates' earnings and profits generated during its taxable year ended March 31, 1971, the cash distributions made by Associates to *570 its shareholders, including those made as of February 9, 1971, were dividends as defined in
In accordance with out conclusions herein and the concessions of the parties,
1. Certain concessions have been made by both parties, the effect of which will be reflected in the Rule 155 computation.↩
2. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise stated.↩
3. On Apr. 28, 1971, the common stock of Associates was split 15-for-1, and 14 new shares were issued as a stock dividend for every share outstanding on that date.↩
1. Rounded to $ 12.↩
2. Rounded to $ 1,566.↩
4.
(a) In General. -- Except as otherwise provided in this chapter, a distribution of property (as defined in section 317(a)) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c).
5. (c) Amount Taxable. -- In the case of a distribution to which subsection (a) applies -- (1) Amount constituting dividend. -- That portion of the distribution which is a dividend (as defined in
6. The parties have stipulated that petitioners' basis in each share of the Associates' stock exceeded the amount of distributions received with respect to the stock. Consequently, to the extent that any of the distributions are found not to constitute dividends, they shall constitute tax-free returns of capital pursuant to
7. See Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 7.03 (3d ed. 1971), for a discussion of earnings and profits and cases and articles cited therein.↩
8. At no time during its taxable years ended Mar. 31, 1971 and 1972, did Associates or its subsidiaries make the election provided in
We also note that under
9.
(a) General Rule. -- For purposes of this subtitle, the term "dividend" means any distribution of property made by a corporation to its shareholders -- (1) out of its earnings and profits accumulated after February 28, 1913, or (2) out of its earnings and profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.
10. This issue is also raised by a stock redemption undertaken by Associates on Mar. 31, 1971. However, on brief respondent claims to have inadvertently stipulated to the amount of Associates' capital account at the time of the redemption. Respondent states that this amount does not represent his position as to the meaning of capital account but due to the stipulation, respondent concedes this issue as it relates to Associates' redemption.
11. In the stipulation of facts the parties stated that the redemption was made in December 1968; on brief they treat Dec. 15, 1968, as the date of redemption.
12.
(a) General Rule. -- If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.
In this case, where the distributor corporation made a cash distribution, whether or not the distribution came within the scope of
13.
14. Respondent does not address the question of whether the method used by CLT to compute the
15. Another factor contributing to the difference in result is the respondent's inclusion of the preferred stock into the computation of the "proper charge" to capital account, i.e., respondent argues that because of the right of the preferred shareholders to participate in dividends after payment of the 4 1/2-percent preferred dividends necessitates including the number of outstanding preferred shares into the denominator with the outstanding common shares to compute the percentage of stock redeemed which is then used to determine the proper charge to capital. We discuss this proposal at pp. 542, 543,
16. For an exhaustive discussion of the history of
17. As defined by sec. 201(g) of the Revenue Act of 1924, amounts paid in partial liquidation included distributions in redemption of part of the corporation's stock.↩
18. See Edelstein & Korbel,
19.
Amount of distribution x amount of earnings and profits/amount of earnings and profits plus capital account
After discussing its interpretations of those opinions the Treasury concluded that they were not inconsistent but "merely reflect necessary differences in the application of a general principle to different types of situations" and thus acknowledged the withdrawal of the nonacquiescence in
20. However, as part of the Revenue Act of 1962 (Pub. L. No. 87-834), Congress promulgated
21.
22.
23. See Reid, "To what extent will distributions in redemption of stock reduce earnings and profits?"
24. The effect of using respondent's formula is to allocate all presumably unrealized appreciation (calculated by arithmetic rather than appraisal or valuation) to capital account. As indicated in some of the writings on this subject referred to elsewhere herein, this allocation can produce some bizarre results on subsequent distributions by the corporation. Here, respondent's computation states that CLT had earnings and profits totaling $ 1,282,599 at the time of the common stock redemption. Under the formula of
25. We believe it noteworthy and indeed find it somewhat distressing that respondent, while devoting a substantial portion of his brief to an examination and interpretation of the legislative history surrounding
26. See, for example,
27. One solution which has been offered as yielding an equitable result under all possible circumstances is put forth in Edelstein & Korbel,
28. As noted in n. 24, respondent's computation of the effect of the 1969 common stock redemption would have left a deficit in CLT's capital account unless an unspecified amount of unrealized appreciation was somehow added to capital account.↩
29. In this regard CLT's treatment of the common stock redemption in fiscal 1969 was theoretically erroneous. CLT accounted for the redemption of 17 percent of the outstanding class A common and 17 percent of the outstanding class B common as a repurchase of 17 percent of the common stock outstanding. This treatment is not in accord with the proper method as described in the text. However, the same percentages of class A and class B shares were redeemed and thus accounting for the redemptions of each class individually yields the same result.
30. New TAACO also paid the compensation of the optionees who were employed by S. & Y. during both of the indicated years. However, this compensation expense was reimbursed by S. & Y. to New TAACO, and S. & Y. claimed the deductions therefor on Associates' consolidated returns for both years.↩
31. This Court maintained the position it took on this issue in
32.
(a) Effect of Qualifying Transfer. -- If a share of stock is transferred to an individual in a transfer in respect of which the requirements of section 422(a), 423(a), or 424(a) are met -- (1) except as provided in section 422(c)(1), no income shall result at the time of the transfer of such share to the individual upon his exercise of the option with respect to such share; (2) no deduction under section 162 (relating to trade or business expenses) shall be allowable at any time to the employer corporation, a parent or subsidiary corporation of such corporation, or a corporation issuing or assuming a stock option in a transaction to which section 425(a) applies, with respect to the share so transferred; and (3) no amount other than the price paid under the option shall be considered as received by any of such corporations for the share so transferred.↩
33. An alternative theory, possibly more in line with the analogies of the transaction by the Seventh Circuit in
34.
(a) General Rule. -- If, in connection with the performance of services, property is transferred to any person other than the person for whom such services are performed, the excess of -- (1) the fair market value of such property * * *, over (2) the amount (if any) paid for such property, shall be included in the gross income of the person who performed such services * * *
* * *
(e) Applicability of Section. -- This section shall not apply to -- (1) a transaction to which
35. According to the stipulation of facts the dual employees of CLT and Associates did not exercise any options during the taxable years here involved.
36. In his brief, respondent has separately discussed the effect of New TAACO's and CLT's payments of other member corporations' employee compensation on the corporations' earnings and profits. Since respondent concludes that no significant net effect results therefrom, and since petitioners on brief indicate their agreement, we will not discuss the situation and direct the parties to exclude its consideration from the Rule 155 computation.↩
37. This precise issue, however, has been decided by the Eighth Circuit Court of Appeals in
38. The amount of the capital account of CLT was the subject of the controversy in issue 1,
39. On brief respondent states that due to his stipulation of the amount of Associates' capital account prior to the stock redemption, he does not argue the applicability of
40. Except for the $ 100 exclusion allowed to each of the petitioners. Sec. 116.↩
41. Of course, under the circumstances of this case, it is to petitioner's benefit to have the distributions in redemption of the corporate stock first charged against earnings and profits. Such distributions would be received by the stockholders as in exchange for their stock,
42.
(a) In General. -- Except as otherwise provided in this chapter, a distribution of property (as defined in section 317(a)) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c).
* * *
(c) Amount Taxable. -- In the case of a distribution to which subsection (a) applies -- (1) Amount constituting dividend. -- That portion of the distribution which is a dividend (as defined in (2) Amount applied against basis. -- That portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock. (3) Amount in excess of basis. -- (A) In general. -- Except as provided in subparagraph (B), that portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or exchange of property.
43.
(a) General Rule. -- If a corporation redeems its stock (within the meaning of section 317(b)), and if paragraph (1), (2), (3), or (4) of subsection (b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for the stock.
* * *
(d) Redemptions Treated as Distributions of Property. -- Except as otherwise provided in this subchapter, if a corporation redeems its stock (within the meaning of section 317(b)), and if subsection (a) of this section does not apply, such redemption shall be treated as a distribution of property to which
44.
(a) General Rule. -- For purposes of this subtitle, the term "dividend" means any distribution of property made by a corporation to its shareholders -- (1) out of its earnings and profits accumulated after February 28, 1913, or (2) out of its earnings and profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time the distribution was made.
45.
(a) General Rule. -- Except as otherwise provided in this section, on the distribution of property by a corporation with respect to its stock, the earnings and profits of the corporation (to the extent thereof) shall be decreased by the sum of -- (1) the amount of money, (2) the principal amount of the obligations of such corporation, and (3) the adjusted basis of the other property so distributed.↩
46. For an extended discussion of the legislative history of
47. Sec. 201(c) explicitly applied to liquidating distributions; sec. 201(g) defined partial liquidations as including redemptions.↩
48. See
49. Additionally we note respondent's reference to the portion of the majority opinion in
50. See sec. 14, Revenue Act of 1936.↩
51. See secs. 14 and 27, Revenue Act of 1936.↩
52. See also the Eighth Circuit's response to this argument in
53. The tax was repealed by the Revenue Act of 1939.↩
54. See, for example, Rudick, "'Dividend' and 'Earnings or Profits' Under Income Tax Law: Corporate Non-Liquidating Distributions,"
55. It is argued that
56. Sec. 311(a) which, per se, does not provide a timing rule also uses the terminology "on the distribution, with respect to its stock."↩
57. See also
Noteman v. Welch , 108 F.2d 206 ( 1939 )
Van Norman Co. v. Welch , 141 F.2d 99 ( 1944 )
Jack E. Golsen and Sylvia H. Golsen v. Commissioner of ... , 445 F.2d 985 ( 1971 )
Commissioner of Internal Revenue v. Hirshon Trust , 213 F.2d 523 ( 1954 )
Harold S. Divine and Rita K. Divine v. Commissioner of ... , 500 F.2d 1041 ( 1974 )
Esmond Mills v. Commissioner of Internal Revenue , 132 F.2d 753 ( 1943 )
The St. Louis Company, a Delaware Corporation (In ... , 237 F.2d 151 ( 1956 )
Gpd, Inc. v. Commissioner of Internal Revenue , 508 F.2d 1076 ( 1974 )
estate-of-wesley-a-steffke-deceased-wisconsin-valley-trust-company-and , 538 F.2d 730 ( 1976 )
Commissioner of Internal Revenue v. Godley's Estate , 213 F.2d 529 ( 1954 )
Helvering v. Jarvis , 123 F.2d 742 ( 1941 )
Missouri-Kansas Pipe Line Co. v. Commissioner of Int. Rev. , 148 F.2d 460 ( 1945 )
Shellabarger Grain Products Co. v. Com'r of Int. Rev. , 146 F.2d 177 ( 1944 )
Sid Luckman and Estelle Luckman v. Commissioner of Internal ... , 418 F.2d 381 ( 1969 )
DeGanay v. Lederer , 39 S. Ct. 524 ( 1919 )
Edwards v. Douglas , 46 S. Ct. 85 ( 1925 )
Hellmich v. Hellman , 48 S. Ct. 244 ( 1928 )
Donald E. Baker and Barbara M. Baker v. United States , 460 F.2d 827 ( 1972 )
Michael C. Callan and Thomas J. Callan, Jr. v. Commissioner ... , 476 F.2d 509 ( 1973 )
Young & Rubicam, Inc. v. The United States , 410 F.2d 1233 ( 1969 )