United States v. Davis, 397 U.S. 301 (1970)

United States v. Davis

No. 282

Argued January 12, 1970
Decided March 23, 1970
397 U.S. 301

CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

Syllabus

Taxpayer organized a corporation with one Bradley, who received 500 shares of common stock (later sold to taxpayer and divided between two of his children), taxpayer and his wife each receiving 250 shares. To increase the company’s working capital and qualify for an RFC loan, taxpayer bought 1,000 shares of preferred stock, at a par value of $25 per share, which the company (in accordance with the original understanding) redeemed when the loan was paid. Taxpayer treated the transaction for income tax purposes as a sale of preferred stock, resulting in no gain to him, since the stock’s basis was $25,000. The Commissioner of Internal Revenue determined that the distribution of that sum was essentially equivalent to a dividend, and reportable as ordinary income under §§ 301 and 316 of the Internal Revenue Code of 1954. That determination was premised on the Commissioner’s finding that, by reason of the rules of attribution in § 318(a) of the Code (under which a taxpayer is considered to own the stock owned by his spouse and children), the taxpayer here must be deemed the owner of all the company’s stock immediately before and after the redemption. The taxpayer paid the resulting deficiency and brought this suit for a refund. The District Court ruled in the taxpayer’s favor. The Court of Appeals affirmed, holding that the $25,000 received by the taxpayer was the final step in a course of action with a legitimate business purpose, and thus "not essentially equivalent to a dividend" within the meaning of § 302(b)(1) of the Code, which qualified the distribution as a "payment in exchange for the stock" and entitled it to capital gains, rather than ordinary income, treatment under § 302(a). Taxpayer contends that the attribution rules do not apply for the purpose of § 302(b)(1); that he should be considered to own only 25 percent of the corporation’s common stock, and that the distribution would qualify under § 302(b)(1), since it was not proportionate to his stock interest, the fundamental test of dividend equivalency.

Held:

1. The attribution rules of § 318(a) apply to all of § 302, and, for the purpose of deciding whether the distribution here is "not essentially 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. Pp. 304-307.

2. Regardless of business purpose, a redemption is always "essentially equivalent to a dividend" within the meaning of § 302(b)(1) if it does not change the shareholder’s proportionate interest in the corporation. Since taxpayer here (after application of the attribution rules) was the corporation’s sole shareholder both before and after the redemption, he did not qualify for capital gains treatment under that test. Pp. 307-313.

408 F.2d 1139, reversed and remanded.