C. Blake McDowell, Inc. v. Commissioner

67 T.C. 1043, 1977 U.S. Tax Ct. LEXIS 130

• Court: United States Tax Court
• Decided: March 30, 1977
• Docket: Docket No. 3852-76
• Status: Published

Opinions

OPINION

Tannenwald, Judge:

Respondent determined the following deficiencies representing personal holding company taxes asserted to be due from petitioner:

Year Deficiency

1972. $12,504.18

1973. 58,740.42

This matter is before the Court on petitioner’s motion for judgment on the pleadings. Respondent has admitted all facts alleged in the petition. A hearing on petitioner’s motion was conducted by Special Trial Judge Lehman C. Aarons and the Court has had the benefit of his analysis in reaching its decision.

Petitioner is a corporation organized under the laws of Ohio, with its principal office in Akron, Ohio, at the time of the filing of the petition herein. It timely filed Federal income tax returns for the calendar years in question with the Internal Revenue Service Center at Cincinnati, Ohio.

On November 19, 1974, there was a determination, within the meaning of section 547(c),¹ that petitioner was liable for the personal holding company tax for 1972 and 1973 in the amounts of $15,364.13 and $59,383.02, respectively. Pursuant to resolution of petitioner’s board of directors, timely deficiency dividends were paid to petitioner’s shareholders (all of whom were noncorporate shareholders) in the amount of $3,881.64 in cash and in shares of stock of another corporation having an adjusted basis of $1,122 to petitioner and an aggregate fair market value on the dates of distribution of $102,900.

Petitioner claimed a deficiency dividend deduction against its personal holding company income under section 547 measured by the fair market value of the distributed stock. Respondent determined that petitioner’s deduction should be limited to its adjusted basis in respect of the property distributed, in accordance with section 1.562-l(a), Income Tax Regs., which provides:

If a dividend is paid in property (other than money) the amount of the dividends paid deduction with respect to such property shall be the adjusted basis of the property in the hands of the distributing corporation at the time of the distribution. * * *

The sole issue before us is the validity of the foregoing regulation. It is a case of first impression for this Court, although the identical issue has been the subject of conflicting decisions by two Courts of Appeals. Fulman v. United States, 545 F.2d 268 (1st Cir. 1976), sustaining the validity of the regulation, and H. Wetter Manufacturing Co. v. United States, 458 F.2d 1033 (6th Cir. 1972), holding the regulation invalid and sustaining the position taken by the petitioner herein.²

The standards for determining the validity of respondent’s regulations are well established:

Treasury regulations must be sustained unless unreasonable and plainly inconsistent with the revenue statutes and * * * they constitute contemporaneous construction by those charged with administration of these statutes which should not be overruled except for weighty reasons. * * * [Commissioner v. South Texas Lumber Co., 333 U.S. 496, 501 (1948).]

Examining the statutory framework, we find that section 541 imposes a special tax on "undistributed personal holding company income (as defined by section 545).” Because a substantial purpose of this tax is to preclude the sheltering of substantial investment income in a corporate entity without distribution thereof to the individual shareholders (see, generally, Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 8.20 (3d ed. 1971)), section 545 defines undistributed personal holding company income as a corporation’s taxable income after certain adjustments. Included in such adjustments is a deduction for "dividends paid * * * as defined in section 561.” Similarly, section 547(a) provides for a deduction for deficiency dividends and section 547(d) defines deficiency dividends as "the amount of the dividends paid * * * which would have been includible in the computation of the deduction for dividends paid under section 561 for the taxable year with respect to which the liability for personal holding company tax exists, if distributed during such taxable year.” Section 561(a)(1) provides for a deduction of "the dividends paid during the taxable year” and section 561(b) provides that "in determining the deduction for dividends paid, the rules provided in section 562 * * * shall be applicable.” Completing the framework is section 562(a), which provides:

(a) General Rule. — For purposes of this part, the term "dividend” shall, except as otherwise provided in this section, include only dividends described in section 316 (relating to definition of dividends for purposes of corporate distributions).

Thus, even after undistributed personal holding company income has been determined, the corporate taxpayer can reduce or eliminate the sting of its tax liability in respect thereof by distributing a "deficiency dividend” as defined in section 547(d) for which it is entitled to a deduction under section 547(a) in computing its personal holding company tax.

Neither section 561 (together with its definitional followup in section 562) nor section 547, providing for the dividends paid deduction and the deficiency dividends deduction, respectively, expresses any valuation procedure for determining the amount of the deduction for dividends in kind.³

Section 562 explains that, in order to be a deductible "dividend,” a distribution must be a dividend described in section 316. That section merely defines dividends by reference to their source of payment;⁴ dividends are distributions from earnings and profits or, in the case of personal holding companies, "any distribution of property * * * made by the corporation to its shareholders, to the extent of its undistributed personal holding company income.” See sec. 316(b)(2)(A).

H. Wetter Manufacturing Co. v. United States, supra, concluded that, by this language, Congress clearly and unambiguously provided for a dividends-paid deduction⁵ in the amount of the fair market value of the property distributed, when such language is read in conjunction with section 301, which provides that the amount of a dividend in kind to a noncorporate distributee is its fair market value in the distributee’s hands.

We think neither section 316 nor section 301 compels this result. The language of section 316 upon which the Sixth Circuit focuses derives from section 186 of the Revenue Act of 1942, ch. 619, 56 Stat. 798, 895-896, which added the language to section 115(a) of the Internal Revenue Code of 1939. The reason for the addition of such language to the tax laws was merely to provide a source for dividend distributions by a personal holding company other than its earnings and profits. Because of differences in the computation of ordinary net income and undistributed personal holding company income, the possibility that a corporation could have undistributed personal holding company income in excess of earnings and profits meant that such corporation could not mitigate its personal holding company tax liability by making distributions if such distributions exceeded earnings and profits and did not qualify as taxable dividends in the recipient shareholders’ hands. To remedy this "anomalous” result, Congress provided an additional source of dividend distributions to personal holding companies. See H. Rept. No. 2333, 77th Cong., 2d Sess. 53, 136-137 (1942), 1942-2 C.B. 372, 414, 473; S. Rept. No. 1631, 77th Cong., 2d Sess. 176-177 (1942), 1942-2 C.B. 504, 634-635.

The addition of this provision to the revenue laws had no effect upon the amount of a dividend distribution to be taken into account by a distributing personal holding company in computing what was then a dividends-paid credit. A specific statutory section (sec. 27(d), I.R.C. 1939) already provided:

Dividends in Kind. — If a dividend is paid in property other than money * * * the amount with respect thereto which shall be used in computing the basic surtax credit shall be the adjusted basis of the property in the hands of the corporation at the time of the payment, or the fair market value of the property at the time of payment, whichever is the lower.

Contemporaneously, section 506(c) of the Internal Revenue Code of 1939 specified that "the term 'deficiency dividends’ mean the amount of the dividends paid * * * which are includible * * * in the computation of the basic surtax credit for the year of distribution.”

Further, prior to 1942, Congress enacted section 115(j) of the 1939 Code, which provided that in the hands of a shareholder a dividend in kind was measured by fair market value at the time of distribution.

It is thus apparent that, from 1942 until 1954, sections 27(d), 115(a) and (j), and 506(c) of the 1939 Code existed side by side. It cannot be gainsaid that, if these provisions, and particularly sections 27(d) and 506(c) of the 1939 Code, had all been specifically incorporated into the 1954 Code revision, the issue involved herein would not have arisen and respondent’s regulation would unquestionably set forth the correct rule. The difficulty arises because this did not occur. The provisions of old section 115(a) and (j) found their way into sections 316(b)(2)(A) and 301(b)(1)(A), respectively, of the 1954 Code. Neither old section 27(d) nor the cross reference language of section 506(c) was specifically set forth in the new Code.

The question, therefore, is whether the fact that these two latter sections did not find an in haec verba place in the 1954 revision sufficiently reveals a legislative intention to overturn the previously existing rule. We think not. Indeed, what little evidence is contained in that history points in the opposite direction. Thus, in discussing section 562, the House Ways and Means Committee stated (H.Rept. No. 1337, 83d Cong., 2d Sess. A181 (1954)):

Subsection (a) provides that the term "dividend” for purposes of this part shall include, except as otherwise provided in this section, only those dividends described in section 312 (relating to definition of dividends for purposes of corporate distributions). The requirements of sections 27(d), (e), (f), and (i) of existing law are incorporated in the definition of ”dividend” in section 312, and accordingly are not restated in section 562. [Emphasis added.]

The Senate Finance Committee made an almost identical statement (S. Rept. No. 1622, 83d Cong., 2d Sess. 325 (1954)):

This section conforms to section 562 of the House bill except for a clerical amendment.

Subsection (a) provides that the term "dividend” for purposes of this part shall include, except as otherwise provided in this section, only those dividends described in section 316 (relating to definition of dividends for purposes of corporate distributions). The requirements of sections 27(d), (e), (f), and (i) of existing law are contained in the definition of "dividend” in section 312, and accordingly are not restated in section 562. [Emphasis added.]

Because section 312 of the House bill became section 316 of the Internal Revenue Code of 1954, there has been some •speculation as to whether there was a typographical error in the second reference of the Senate report. See Fulman v. United States, 545 F.2d at 270 n.2, as well as the discussion in the District Court opinion (see 407 F.Supp. at 1039 n.5 (D. Mass. 1976)). In our view, it is unnecessary, for the purposes of decision herein, to resolve the editorial or printing conundrum thus posed. Clearly, any confusion thereby created cannot be said to evince an intent on the part of Congress to change or eliminate the rule laid down by section 27(d) of the 1939 Code. Indeed, whether Congress was referring to section 312 or section 316, the committee language that "the requirements of [section] 27(d) * * * of existing law are incorporated [contained]” not only does not hint of any change but indicates the belief that the old rule would continue to be applied.

Moreover, such change or elimination would have been a substantial departure from the prior treatment of personal holding companies. At least where the adjusted basis of distributed property is less than its fair market value at the time of distribution, personal holding companies would have been treated far more generously than in the past and the aggregate tax bite could have been sharply reduced by making deficiency dividends in kind. Certainly, Congress has not otherwise indicated its intent to extend such generous treatment to personal holding companies.

A further indication of the consistency of the "adjusted basis” rule with the current statutory pattern is the "consent dividend” provision contained in section 565. Under that provision, Congress has indeed prescribed a way in which a personal holding company may retain its realized earnings and still escape the impact of the penalty tax. But, under the consent dividend procedure, the shareholder pays the full tax at the individual level and ends up with nothing in his pocket other than a receipt for a capital contribution in the amount of the dividend that he did not in fact receive. The disposition sought by the petitioner here, if finally sanctioned by the courts, would enable a personal holding company (such as a family investment company) to retain its realized earnings in a far less painful manner, i.e., by actually distributing its appreciated securities and still having its retained earnings as working capital for further investments — without paying the penalty tax. Such a result should not prevail unless clearly mandated by the statute.

Thus, we are satisfied that sections 316 and 301 do not justify overturning respondent’s regulations. Those sections had their genesis in the comparable provisions of the 1939 Code, which could not have enunciated any valuation procedure for a personal holding company dividends-paid deduction since a separate section articulated the statutory yardstick. Nothing in the legislative history indicates that sections 316 and 301 should be accorded an interpretation which would establish an entirely new measuring rod. In short, such sections do no more than had been done historically, namely, define dividends in respect of source of payment and determine the extent of a distributee shareholder’s receipt.

Nor are we convinced that section 312(a)⁶ necessarily provides the touchstone for decision. See Fulman v. United States, supra. That section prescribes adjusted basis as the appropriate measure of the charge to corporate earnings and profits for distributions in kind. The only significance of section 312 is that, unlike sections 316 and 301, it concerns the effect of a dividend on the earnings and profits of distributing corporations. Since section 312 is applicable to corporations generally and most corporations (unlike personal holding companies) merely account for but do not deduct dividends paid, it offers only indirect assistance in answering the question before us, although we believe it fair to observe that it has a greater bearing than either section 316 or 301.

We are unimpressed by the argument, essentially grounded on policy considerations, that so long as the distributee is taxed on the full value of the distribution, the distributing corporation should be allowed a deduction for the same amount. This argument was available prior to 1954 and yet for more than a decade Congress saw fit to measure the deduction in terms of the distributing corporation’s investment rather than the distributee’s taxable receipt. Indeed, there is a discernible rationale that this was done to effectuate a countervailing policy of taxing or forcing distribution of income rather than unrealized appreciation. See Fulman v. United States, supra. Cf. Ivan Allen Co. v. United States, 422 U.S. 617 (1975). Under these circumstances, we can perceive no basis for concluding that respondent’s regulation is so unrealistic as to be unreasonable. Cf. United States v. Cartwright, 411 U.S. 546 (1973).

In sum, we are confronted with a situation where the Code is silent in terms of a specific direction in respect of the issue before us and the legislative history is at most ambiguous. Respondent’s regulations represent a contemporaneous construction of the 1954 Code; they have been in effect since 1958⁷ and are substantially a continuation of prior law.⁸ In this context and applying the standard set forth in Commissioner v. South Texas Lumber Co., 333 U.S. 496 (1948) (see p. 1045 supra), we conclude that the validity of respondent’s regulation should be sustained.

Our conclusion does not, however, dictate that petitioner’s motion should not be granted. An appeal from our decision herein lies to the Sixth Circuit Court of Appeals and that court has already decided the issue involved herein and invalidated respondent’s regulation. H. Wetter Manufacturing Co. v. United States, supra. In accordance with the policy enunciated in Jack E. Golsen, 54 T.C. 742, 757 (1970), affd. on the substantive issue 445 F.2d 985 (10th Cir. 1971), we have articulated our views on the merits, even though we are mandated by Golsen to apply the rule of Wetter herein. Cf. Of Course, Inc., 59 T.C. 146, 148 (1972), revd. on substantive grounds 499 F.2d 754 (4th Cir. 1974), where there was a conflict among the Courts of Appeals and we took issue with the Court of Appeals to which the appeal therein lay, adhered to our previously expressed position which that court had previously reversed, and persuaded the Court of Appeals to change its position.

In accordance with the foregoing, petitioner’s motion for judgment on the pleadings will be granted.

An appropriate order and decision will be entered.

Reviewed by the Court.

1 Unless otherwise stated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in issue.

2 The issue involved herein is also pending in the Fifth Circuit. See Gulf Inland Corp. v. United States, F.Supp. (W.D. La. 1975), on appeal (5th Cir., Oct. 14, 1975). We note that Wetter dealt with a deduction under sec. 561 for a current dividend in kind rather than a deficiency dividend as is the case in Fulman and herein. But respondent’s regulation is equally applicable to deductions for dividends paid under sec. 561 and sec. 547 (see sec. 1.547-2(a)(3), Income Tax Regs.), the only difference between the two types of dividends being the time when they are paid.

3 The former section speaks of a deduction for "the sum” of various dividends; the latter speaks of a deduction for "the amount of deficiency dividends.”

4 The pertinent portions of sec. 316 are:

SEC. 316. DIVIDEND DEFINED.

(a) General Rule. — For the 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.

Except as otherwise provided in this subtitle, every distribution is made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings and profits. To the extent that any distribution is, under any provision of this subchapter, treated as a distribution of property to which section 301 applies, such distribution shall be treated as a distribution of property for purposes of this subsection.

(b) Special Rules.—

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(2) Distributions by personal holding companies.—

(A) In the case of a corporation which—

(i) under the law applicable to the taxable year in which the distribution is made, is a personal holding company (as defined in section 542), or

(ii) for the taxable year in respect of which the distribution is made under section 563(b) (relating to dividends paid after the close of the taxable year), or section 547 (relating to deficiency dividends), or the corresponding provisions of prior law, is a personal holding company under the law applicable to such taxable year,

the term "dividend” also means any distribution of property (whether or not a dividend as defined in subsection (a)) made by the corporation to its shareholders, to the extent of its undistributed personal holding company income (determined under section 545 without regard to distributions under this paragraph) for such year.

5 See n. 2 supra.

6 SEC. 312. EFFECT ON EARNINGS AND PROFITS.

(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.

7 T.D. 6308, 1958-2 C.B. 279, 313, 338-339.

8 Where fair market value exceeds adjusted basis, the regulations adopt the old rule. Where fair market value is less than adjusted basis, respondent would allow a larger deduction than that permitted under prior law.