131 T.C. No. 4
UNITED STATES TAX COURT
RALSTON PURINA COMPANY AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7357-00. Filed September 10, 2008.
P, a Missouri corporation, claimed a deduction under I.R.C. sec. 404(k) for payments made to its employee stock ownership plan in redemption of P’s preferred stock owned by the plan, where the proceeds of that payment were distributed to employees terminating their participation in the plan. R argues that payments to redeem stock are not deductible under either I.R.C. sec. 404(k)(1) or (5), or in the alternative that deduction of these payments is barred by the provisions of I.R.C. sec. 162(k).
Held: I.R.C. sec. 162(k) renders the payments nondeductible because the payments are in connection with a redemption of stock. The result to the contrary reached by the U.S. Court of Appeals for the Ninth Circuit on almost identical facts in Boise Cascade Corp. v. United States, 329 F.3d 751 (9th Cir. 2003), respectfully will not be followed. - 2 -
Kenneth A. Kleban, for petitioner.
Lawrence C. Letkewicz and Dana E. Hundrieser, for
respondent.
OPINION
NIMS, Judge: Before the Court are petitioner’s and
respondent’s cross-motions for summary judgment pursuant to Rule
121.
Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code in effect for the
years in issue.
Rule 121(a) provides that either party may move for summary
judgment upon all or any part of the legal issues in controversy.
Full or partial summary judgment may be granted only if it is
demonstrated that no genuine issue exists as to any material fact
and that the legal issues presented by the motion may be decided
as a matter of law. See Rule 121(b); Sundstrand Corp. v.
Commissioner, 98 T.C. 518, 520 (1992), affd. 17 F.3d 965 (7th
Cir. 1994). As to the issues presented on these cross-motions
for summary judgment, we conclude that there is no genuine issue
as to any material fact and that a decision may be rendered as a
matter of law. - 3 -
The sole issue remaining for decision is whether petitioner
may claim deductions for amounts paid in redemption of preferred
stock held by its employee stock ownership plan (ESOP) for its
1994 and 1995 tax years. This issue was raised for the first
time by petitioner in its second amendment to petition (second
amendment). All other issues, of which there were many, have
been settled. Respondent consented to the filing of the second
amendment.
Background
The parties filed an extensive stipulation of facts with
accompanying exhibits which forms the factual setting for their
respective arguments and which provides the basis for our
Background discussion.
Petitioner is a Missouri corporation and had its principal
place of business in St. Louis, Missouri, when its petition was
filed. In 1989 petitioner amended its Savings Investment Plan
(SIP or plan) for employees, adding an employee stock ownership
plan (ESOP). Boatmen’s Trust Co. (Boatmen’s) was trustee of the
ESOP portion of the SIP. Vanguard Fiduciary Trust Co. was named
recordkeeper for the SIP and was responsible for making
distributions to plan participants. The trust fund under the SIP
was exempt from income tax under section 501(a). For
convenience, references hereinafter to the SIP include, where
appropriate, the trust fund under the SIP. - 4 -
The managers of the SIP created a Benefits Policy Board
(BPB) comprising employees appointed by petitioner’s chief
executive officer. They also created an Employee Benefit Asset
Investment Committee (EBAIC), the members of which were appointed
by petitioner’s board of directors. Petitioner’s board of
directors, the BPB, the EBAIC, and the trustees were among the
fiduciaries responsible for the administration of the SIP.
Boatmen’s trust agreement provided that Boatmen’s would make
distributions from the SIP in cash or in kind to such person, in
such amounts, at such times, and in such manner as directed by
the EBAIC. The EBAIC could, at its sole discretion, direct
Boatmen’s to pay any cash dividends on shares of preferred stock
(see below for definition) directly to plan participants. The
EBAIC could also decide how any payments to plan participants
would be funded. Petitioner could not use amounts in the SIP for
any purpose other than the benefit of the SIP participants.
In connection with the creation of the ESOP, petitioner’s
board authorized the issuance of 4,600,000 shares of newly
created convertible preferred stock (preferred stock). These
shares could be issued only in the name of an ESOP trustee and
were not readily tradable on an established market. Shares of
the preferred stock were entitled to receive, when, as, and if
declared by petitioner’s board, cumulative cash dividends (stated - 5 -
dividends) in an amount per share equal to $7.48 per annum,
payable semiannually, one-half on June 29 and one-half on
December 30 of each year commencing June 29, 1989.
On February 1, 1989, the SIP purchased 4,511,414 shares of
preferred stock from petitioner at $110.83 per share. To finance
this purchase, the SIP borrowed $500 million from institutional
lenders. Petitioner guaranteed the ESOP loans. The loans
matured in approximately 10 years with principal and interest
payable semiannually.
The SIP purchased an additional 88,586 shares of preferred
stock during the years 1990-92, also at $110.83 per share. The
SIP funded these purchases through employee contributions.
Plan participants could make contributions to the ESOP up to
6 percent of their before-tax income. Any contributions in
excess of 6 percent were invested outside the SIP in investment
funds of the participant’s choosing. Participants were not
permitted to invest any after-tax income in the ESOP.
Participants’ basic matched contributions were fully vested at
all times. Company matching contributions became vested over a
period of 4 years. These matching contributions also included
payments by petitioner to the ESOP preferred stock fund in
amounts necessary to make ESOP loan amortization payments.
Employee participation in the SIP ended upon termination of
employment for any reason. Terminated participants had the - 6 -
option, among others, to cash out their investment in the ESOP.
The SIP could, in its sole discretion, require petitioner to
redeem shares of preferred stock at any time upon notice, when
and to the extent necessary to provide required distributions to
terminated participants electing to cash out their investments,
or to make payments on the ESOP loan. The payment by the SIP to
terminated participants could be made, at the SIP’s option, in
cash or shares of petitioner’s common stock. The SIP also had
the option to satisfy distributions to terminated participants
without forcing petitioner to redeem stock.
At all relevant times the plan year of the SIP was the
calendar year. For plan years 1989 through 1993 the SIP made
distributions to terminated participants using cash otherwise
available to it.
The first relevant redemption by petitioner of preferred
stock held by the SIP occurred in August 1994. Petitioner
redeemed 28,224 shares of preferred stock for $3,128,066. The
SIP distributed that entire amount to terminated participants by
December 31, 1994. During this period the SIP also made
$1,589,696 in distributions to terminated participants out of
cash otherwise available.
In February 1995 petitioner redeemed another 56,645 shares
of preferred stock from the SIP for $6,277,965. All of the
proceeds were distributed to terminating participants from - 7 -
February 21 through July 20, 1995. During this period the SIP
made additional distributions of $1,927,624 from cash otherwise
available.
Petitioner timely filed consolidated Forms 1120, United
States Corporation Income Tax Return, for its taxable years
ending September 30, 1994 and 1995. Respondent issued a
statutory notice of deficiency to petitioner dated April 6, 2000,
pertaining to petitioner’s 1993, 1994, and 1995 tax years.
Petitioner filed a petition contesting many of the adjustments
respondent made in the notice of deficiency, none of which
concerned petitioner’s ESOP. Petitioner filed an amendment to
petition on February 24, 2003, and the second amendment on
December 9, 2003. In the second amendment petitioner asserted
for the first time that it was entitled to an additional
deduction, under section 404(k), for amounts it paid to the SIP
to redeem its preferred stock that were then distributed to plan
participants.
Discussion
Petitioner claims as deductions its payments in redemption
of preferred stock held by the SIP the proceeds of which the SIP
subsequently distributed to terminating employees. Petitioner
contends these payments are essentially equivalent to dividends
within the meaning of section 302(b)(1) (redemption dividends).
Respondent does not challenge this contention--rather that the - 8 -
redemption dividends are deductible. The SIP used the redemption
dividends to make distributions to the employee participants in
the SIP who had terminated their participation because of
retirement or for some other reason.
Petitioner asserts that the redemption dividends qualify as
applicable dividends under section 404(k)(2). For the taxable
years at issue, section 404(k) provided in relevant part:
SEC. 404(k). Deduction for Dividends Paid on Certain Employer Securities.--
(1) General rule.--In the case of a corporation, there shall be allowed as a deduction for a taxable year the amount of any applicable dividend paid in cash by such corporation during the taxable year with respect to applicable employer securities. Such deduction shall be in addition to the deductions allowed under subsection (a).
(2) Applicable dividend.--For purposes of this subsection--
(A) In general.--The term “applicable dividend” means any dividend which, in accordance with the plan provisions--
(i) is paid in cash to the participants in the plan or their beneficiaries,
(ii) is paid to the plan and is distributed in cash to participants in the plan or their beneficiaries not later than 90 days after the close of the plan year in which paid, or
(iii) is used to make payments on a loan described - 9 -
in subsection (a)(9) the proceeds of which were used to acquire the employer securities (whether or not allocated to participants) with respect to which the dividend is paid.
* * * * * * *
(3) Applicable employer securities.--For purposes of this subsection, the term “applicable employer securities” means, with respect to any dividend, employer securities which are held on the record date for such dividend by an employee stock ownership plan which is maintained by--
(A) the corporation paying such dividend, or
(4) Time for deduction.--
(A) In general.--The deduction under paragraph (1) shall be allowable in the taxable year of the corporation in which the dividend is paid or distributed to a participant or his beneficiary.
(B) Repayment of loans.--In the case of an applicable dividend described in clause (iii) of paragraph (2)(A), the deduction under paragraph (1) shall be allowable in the taxable year of the corporation in which such dividend is used to repay the loan described in such clause.
(5) Other rules.--For purposes of this subsection--
(A) Disallowance of deduction.--The Secretary may disallow the deduction under - 10 -
paragraph (1) for any dividend if the Secretary determines that such dividend constitutes, in substance, an evasion of taxation.
(6) Definitions.--For purposes of this subsection--
(A) Employer securities.--The term “employer securities” has the meaning given such term by section 409(l).
(B) Employee stock ownership plan.--The term “employee stock ownership plan” has the meaning given such term by section 4975(e)(7). Such term includes a tax credit employee stock ownership plan (as defined in section 409).
Respondent does not challenge the treatment of the preferred
stock as “employer securities” as defined in section 409(l).
Petitioner raised this section 404(k) issue for the first
time in the second amendment, which, as stated above, petitioner
filed without objection by respondent, after the decision of the
U.S. Court of Appeals for the Ninth Circuit in Boise Cascade
Corp. v. United States, 329 F.3d 751 (9th Cir. 2003), on May 20,
2003. In that case the Court of Appeals decided an ESOP
preferred stock redemption issue almost identical to the issue
for decision in this case. The Boise Cascade Corp. result is not
controlling in this case, in which any appeal would normally lie - 11 -
to the Court of Appeals for the Eighth Circuit. See Golsen v.
Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir.
1971).
Respondent maintains that the issue was incorrectly decided
by the Court of Appeals for the Ninth Circuit and challenges the
claimed deductions on three grounds: (1) The redemption
dividends are not applicable dividends within the meaning of
section 404(k); but (2) even if the redemption dividends
otherwise constitute applicable dividends as defined by section
404(k), their deduction should be disallowed as evasions of
taxation under section 404(k)(5); and (3) even if the redemption
dividends are otherwise allowable as deductions under section
404(k), they are disallowed as amounts paid by a corporation in
connection with the redemption of its stock within the meaning of
section 162(k).
In reaching our decision we need not traverse petitioner’s
convoluted arguments in support of its position that the
redemption dividends qualify as applicable dividends under
section 404(k)(2), or respondent’s arguments regarding section
404(k)(5), because in our view section 162(k) precludes that
result in any event, notwithstanding the contrary position taken
by the Court of Appeals. - 12 -
Section 162(k) provides:1
SEC. 162(k). Stock Redemption Expenses.--
(1) In general.--Except as provided in paragraph (2), no deduction otherwise allowable shall be allowed under this chapter for any amount paid or incurred by a corporation in connection with the redemption of its stock.
(2) Exceptions.--Paragraph (1) shall not apply to--
(A) Certain specific deductions.--Any--
(i) deduction allowable under section 163 (relating to interest), or
(ii) deduction for dividends paid (within the meaning of section 561).
(B) Stock of certain regulated investment companies.--Any amount paid or incurred in connection with the redemption of any stock in a regulated investment company which issues only stock which is redeemable upon the demand of the shareholder.
1 The Small Business Job Protection Act of 1996, Pub. L. 104-188, sec. 1704(p), 110 Stat. 1886, amended sec. 162(k)(1) by striking “the redemption of its stock” and inserting “the reacquisition of its stock” effective for amounts paid or incurred after Sept. 13, 1995, in tax years ending after that date. The net effect of the amendment was simply to broaden the scope of sec. 162(k)(l) beyond the technical boundaries of “redemption”. This amendment does not apply to petitioner’s redemptions, for while petitioner’s 1995 fiscal year ended on Sept. 30, 1995, all of the redemption and distribution transactions occurred before Sept. 13, 1995. - 13 -
The redemption dividends do not fall within the exceptions
provided in section 162(k).
Petitioner seeks to have us adopt the position taken by the
Court of Appeals that, as discussed below, the distribution
payments from the ESOP were not “in connection with” the
redemption payments made by petitioner and as a result the entire
transaction did not run afoul of section 162(k).
The Court of Appeals’ rationale runs along the following
lines. The parties stipulated that for purposes of section
302(b), if the ESOP is treated as the owner of the redeemed
preferred stock, then the redemptions did not result in a
meaningful reduction in the ESOP’s proportionate interest in
petitioner and thus would qualify for dividend treatment under
section 316. The Court of Appeals concluded that the ESOP was
the owner of the stock; this established the status of the stock
redemption payments as dividends. The court then had to
determine whether this dividend ran afoul of section 162(k).
Section 162(k) itself is an exception to the general rule of
section 162(a) that permits a deduction for all “ordinary and
necessary expenses paid or incurred during the taxable year in
carrying on any trade or business”. It prohibits deductions for
expenses that would ordinarily be deductible business expenses
but for the fact that those expenses were made in connection with
a repurchase of stock. In the words of the court in Boise - 14 -
Cascade Corp. v. United States, supra at 756: “Section 162(k)
prohibits deductions claimed as a consequence of a stock
redemption. Thus, it acts as a disallowance provision for
otherwise allowable non-capital deductions incurred in connection
with a stock redemption transaction.” Boise Cascade Corp. goes
on to say that “the key question is whether distributions to the
[ESOP] Participants were payments made ‘in connection with’ the
redemption of the convertible preferred stock.” Id. at 757.
In a nutshell, Boise Cascade Corp. appears to proceed on the
premise that if distribution payments to the withdrawing ESOP
participants are made “in connection with” redemption of stock,
then section 162(k) disallows a deduction for the amounts paid.
The Court of Appeals then held that the payments were not made in
connection with the redemption of its stock. Id. at 757-758.
The Court of Appeals’ holding relied heavily on its
previous decision in United States v. Kroy (Europe) Ltd., 27 F.3d
367 (9th Cir. 1994), regarding the meaning of the phrase “in
connection with” in section 162(k). In Kroy, the Court of
Appeals interpreted the phrase narrowly to hold that expenses
incurred to borrow funds used to effect a redemption were not in
connection with a redemption. The court reasoned that Congress,
in enacting section 162(k), did not intend to overrule the
“origin of the claim” test for determining whether expenses were
deductible under section 162 generally. Id. at 369-370. - 15 -
Therefore, the court interpreted the phrase “in connection with”
to include only expenses that have their origin in a stock
redemption transaction, excluding expenses that have their origin
in a “separate, although related, transaction”. Id. at 369.
We specifically rejected the Court of Appeals’ narrow
interpretation of the phrase “in connection with” in United
States v. Kroy (Europe) Ltd., supra. See Fort Howard Corp. &
Subs. v. Commissioner, 103 T.C. 345 (1994). In Fort Howard, we
noted that Congress had expressly intended the phrase to be
construed broadly, to include all deductions necessary or
incident to a redemption transaction. Id. at 353-354 (citing S.
Rept. 99-313, at 223 (1986), 1986-3 C.B. (Vol. 3) 1, 223). We
also relied heavily on the opinion of the Court of Appeals for
the Eighth Circuit in Huntsman v. Commissioner, 905 F.2d 1182
(8th Cir. 1990), revg. 91 T.C. 917 (1988), which held that the
phrase “in connection with” should be broadly construed. We
concluded that the origin of the claim test had no bearing on the
section 162(k) inquiry, rejecting Kroy’s assumption that the “in
connection with” test under section 162(k) must be fashioned in
such a way as to be consistent with the origin of the claim test.
We also concluded that Congress could not have intended section
162(k) as a mere clarification of existing law, because section
162(k) prohibits deductions that are “otherwise allowable” under
present law. Fort Howard Corp. & Subs. v. Commissioner, supra at - 16 -
356. Two years after our Opinion in Fort Howard, Congress
enacted retroactive relief for the borrowing expenses involved in
both Fort Howard and Kroy. See Fort Howard Corp. & Subs. v.
Commissioner, 107 T.C. 187 (1996). Ultimately, our holding in
this case does not depend on our interpretation of the phrase “in
connection with” because we conclude that Congress expressly
intended section 162(k) to prohibit deduction of the funds used
to effect a redemption. See infra pp. 21-22.
Petitioner urges us to adopt the Court of Appeals for the
Ninth Circuit’s reasoning, arguing that while the transaction as
a whole qualifies for a deduction under section 404(k), the
distribution payments from the SIP to terminating employees are
not connected with petitioner’s redemption of its preferred stock
and thus do not run afoul of section 162(k).
We note at the outset that this line of argument appears to
be facially inconsistent. Petitioner first argues that the
redemption payments from petitioner to the SIP and the
distribution payments from the SIP to the employees are linked in
an integrated transaction, so that the transaction fits within
one of the transactions permissible under section 404(k)--a
dividend payment from a corporation to a plan and a distribution
of those proceeds to departing employees. Petitioner then argues
that these payments are in fact not connected for purposes of
section 162(k). Petitioner seems to want it both ways; it relies - 17 -
on the integrated form of the transaction to justify a section
404(k) deduction only to deny that form in another context. See
Portland Golf Club v. Commissioner, 497 U.S. 154, 168 (1990)
(noting an “inherent contradiction” where taxpayer relied on two
methods of calculation to simultaneously show actual losses and
an intent to profit).
While this contradiction tends to undercut petitioner’s
argument, there is a more serious flaw in petitioner’s argument:
both petitioner and the Court of Appeals for the Ninth Circuit
have framed the section 162(k) issue incorrectly. The Court of
Appeals in Boise Cascade Corp. v. United States, 329 F.3d 751
(9th Cir. 2003), held, and petitioner asserts, that the proper
question for section 162(k) purposes is whether the distribution
payment is “in connection with” a redemption. The court offers
no rationale for framing the issue as it does. We infer, as
petitioner does, that the court believed that the distribution
payment from the SIP to the departing employees was the payment
for which the taxpayer sought a deduction. This belief is
incorrect, as it misunderstands the nature of the deduction
sought under section 404(k).
Section 162(k) bars the deduction of “otherwise allowable”
deductions that are made in connection with a repurchase of
stock. The deduction sought is the section 404(k) deduction.
Section 404(k)(1) provides that a corporation is entitled to a - 18 -
deduction for “any applicable dividend” that it pays with respect
to applicable employer securities. (We shall assume, arguendo,
that deductions for the payments petitioner made here would
normally be allowable under section 404(k).) A deduction under
section 404(k) is not allowable unless the transaction qualifies
as an applicable dividend. Thus, the proper question for section
162(k) purposes is whether the otherwise deductible applicable
dividends that petitioner paid are “in connection with” a
repurchase of stock. To answer this question, we must identify
the transaction that constitutes the applicable dividend.
As for what payment in this case could constitute an
applicable dividend under section 404(k), there are three
possibilities: (1) The redemption payment from petitioner to the
SIP, (2) the distribution payments from the SIP to departing
employees, or (3) the redemption payment to the SIP and the
distribution from the SIP as an integrated transaction. The
court in Boise Cascade Corp. v. United States, supra, without
analysis of section 404(k), determined that the second option was
correct--that the distribution payment from the plan to the
departing employees was the deductible applicable dividend to be
analyzed under section 162(k). Id. at 754 (“if the distributions
to the employees were a distribution under § 301, then they were
a ‘dividend’ for the purposes of § 316 and the deduction provided
for in § 404(k) applies”). For the reasons discussed below, that - 19 -
position is unsupportable under section 404(k). Rather, it is
both the redemption payment and the distribution of that payment,
as an integrated transaction, that constitutes the applicable
dividend under section 404(k).
Under section 404(k)(1), a corporation is entitled to a
deduction for applicable dividends that the corporation pays--
either to an ESOP or to plan participants directly. Payments
made to an ESOP must then be distributed by the ESOP, either to
plan participants or to pay off ESOP debt. Sec. 404(k)(2). An
applicable dividend, as applied here, is “any dividend which
* * * is paid to the plan and is distributed in cash to
participants in the plan or their beneficiaries not later than 90
days after the close of the plan year”. Sec. 404(k)(2)(A).
Thus, the applicable dividend as defined requires both a payment
from a corporation and a distribution of that payment to
departing employees.
Petitioner made payments in redemption of the preferred
stock held by the SIP. The redemption payments were made by
petitioner (the corporation) to the SIP (the plan). The SIP
properly distributed those payments. The redemption payments fit
the technical definition of a dividend for purposes of sections
301 and 316, because the redemptions did not result in a
meaningful reduction in the ESOP’s proportionate interest in - 20 -
petitioner. See sec. 302(b). However, they would not have been
applicable dividends unless the SIP later distributed those
payments in the prescribed manner.
Distribution payments from the SIP to terminating employees,
standing alone, do not fit the definition of applicable dividends
for two reasons. First, an applicable dividend must be paid by
the corporation, and the SIP is not the corporation--petitioner
is. Second, the distributions from the SIP are not dividends at
all, because a dividend is defined as a payment by a corporation
to its shareholders. Sec. 316(a). The SIP is the owner of the
preferred stock; it cannot be the payor of dividends under
section 316. These distribution payments represent only the
distribution of the proceeds of a dividend paid by petitioner to
the SIP. Thus, a distribution payment alone cannot be an
applicable dividend as that term is defined under section 404(k).
Rather, both sides of these redemption transactions--redemption
and distribution--are necessary for the transactions to fit the
definition of applicable dividends found in section 404(k).
Petitioner argues that the SIP distribution alone must be
the deductible applicable dividend because that distribution
determines the timing and the amount of the deduction, as the SIP
can choose the amount of petitioner’s payment that it distributes
to employees and when it distributes that payment. As stated
above, no payment from petitioner to the SIP would be deductible - 21 -
under section 404(k) without subsequent distribution--either to
terminating participants or to pay off SIP debt. See sec.
404(k)(2)(A)(ii) and (iii). However, the reverse is true as
well: without a payment from petitioner to the SIP, no
distribution from the SIP would be deductible, because section
404(k)(1) requires that the “applicable dividend” be paid “by
such corporation.” For that reason, petitioner cannot claim a
deduction for the distributions the SIP made to employees out of
Similarly, the court in Boise Cascade Corp. v. United
States, 329 F.3d at 757-758, was incorrect when it framed the
section 162(k) test as being whether the distribution payment
from the plan was “in connection with” a redemption, because the
distribution, standing alone, is not deductible under section
404(k), and without an allowable deduction a section 162(k)
analysis is not necessary. The “connection” that must be made is
between the redemption payment and the distribution payment as
required by section 404(k). The payment from petitioner to the
SIP to the departing employees is a statutorily integrated
transaction. The two sides of the transaction are necessarily
connected, because the SIP must distribute the same funds paid to
it by petitioner. Once that connection is established, deduction
under section 404(k) is possible. That entire transaction, now
potentially deductible as an applicable dividend under section - 22 -
404(k), must also pass muster under section 162(k). The test is
whether the “otherwise allowable” deduction for the payment of an
applicable dividend is nevertheless disallowed because the
payment is “in connection with” a repurchase of stock.
Petitioner’s payments of these asserted applicable dividends
were certainly in connection with a repurchase of stock. The
first part of the applicable dividend transaction was the
redemption. The funds of the transaction, passed from petitioner
to the SIP to the departing employees, are the same funds used to
repurchase stock. Section 162(k) bars a deduction for the
payment of funds used to repurchase stock. See S. Rept. 99-313,
at 223 (1986), 1986-3 C.B. (Vol. 3) 1, 223 (“The committee
intends that amounts subject to this provision will include
amounts paid to repurchase stock”). Therefore, the first part of
the integrated transaction--the redemption of stock from the SIP-
-ensures that section 162(k) bars the deduction of any portion of
the transaction.
As a result, we hold that section 162(k) prevents petitioner
from claiming as deductions the amounts it paid to repurchase its
own stock from its ESOP which were then distributed to
terminating employees. For the reasons given, we respectfully
decline to follow the contrary result reached on almost identical - 23 -
facts by the U.S. Court of Appeals for the Ninth Circuit in Boise
Cascade Corp. v. United States, 329 F.3d 751 (9th Cir. 2003).2
Therefore, we shall grant respondent’s motion for summary
judgment and deny petitioner’s motion for summary judgment. In
doing so, we have considered all of the parties’ arguments, and
to the extent not discussed, we find them moot. In accordance
with the foregoing,
An appropriate order will
be issued, and decision will be
entered under Rule 155.
Reviewed by the Court.
COLVIN, COHEN, SWIFT, WELLS, HALPERN, VASQUEZ, GALE, THORNTON, MARVEL, HAINES, WHERRY, and HOLMES, JJ., agree with this majority opinion.
GOEKE and KROUPA, JJ., did not participate in the consideration of this opinion.
2 We note that the decision of the District Court in Conopco, Inc. v. United States, 100 AFTR 2d 5296, 2007-2 USTC par. 50,582 (D.N.J. 2007), is to a similar effect, in that it disagrees with the holding in Boise Cascade. Contra General Mills, Inc. v. United States, 101 AFTR 2d 550, 2008-1 USTC par. 50,141 (D. Minn. 2008). - 24 -
SWIFT, J., concurring: Regardless of whether petitioner’s
redemption dividends should be disallowed under section
162(k)(1), respondent argues in the alternative that the
redemption dividends should be disallowed pursuant to his
determination under section 404(k)(5)(A). Thereunder, Congress
provided that “The Secretary may disallow the deduction under
* * * [section 404(k)(1)] for any dividend if the Secretary
determines that such dividend constitutes, in substance, an
evasion of taxation.”
In the light of case authority that redemption dividends
should not be disallowed under section 162(k)(1),1 I believe this
Court should address respondent’s alternative argument under
section 404(k)(5)(A).
It is most unusual in a particular Code section to have an
express and specific delegation to the Secretary of authority to
disallow on the grounds of tax evasion the very deduction
provided in the section. On its face and given its placement in
1 Although one court has upheld the Commissioner’s disallowance under sec. 162(k)(1) of deductions for redemption dividends, see Conopco, Inc. v. United States, 100 AFTR 2d 5296, 2007-2 USTC par. 50,582 (D.N.J. 2007) (unpublished opinion, see 8th Cir. R. 32.1A), three courts have rejected sec. 162(k)(1) as a basis for disallowing deductions for redemption dividends, see, e.g., Boise Cascade Corp. v. United States, 329 F.3d 751 (9th Cir. 2003), affg. 82 AFTR 2d 7249 (D. Idaho 1998); General Mills, Inc. v. United States, 101 AFTR 2d 550, 2008-1 USTC par. 50,141 (D. Minn. 2008). General Mills and Conopco are pending appeal to the United States Courts of Appeals for the Third and the Eighth Circuits, respectively. - 25 -
section 404(k), section 404(k)(5)(A) appears to give the
Secretary authority to do just that.
In section 7805(a) Congress has delegated to the Secretary
general authority to promulgate interpretative rules and
regulations, and in a number of Code sections Congress has
delegated to the Secretary additional authority to promulgate
regulations under the specific sections. The jurisprudence
relating to the deference to be given such regulations is well
known. See, e.g., Chevron U.S.A., Inc. v. Natural Res. Def.
Council, Inc., 467 U.S. 837 (1984); Swallows Holding, Ltd. v.
Commissioner, 515 F.3d 162 (3d Cir. 2008), vacating 126 T.C. 96
(2006).
The delegation Congress made to the Secretary in section
404(k)(5)(A), however, is particularly specific and broad and is
not limited to the promulgation of regulations. In section
404(k)(5)(A) Congress appears to have delegated to the Secretary
authority to place a “tax evasion” label on a particular
transaction or type of transaction by regulation, by ruling, or
by other public or private notice. No particular requirement or
limitation is set forth in section 404(k)(5)(A) as to how the
Secretary is to make the “tax evasion” determination, as to how
specific and detailed the Secretary’s public explanation thereof
need be, or as to how the Secretary is to make the “tax evasion”
announcement. - 26 -
For a number of years now and on a number of occasions,
under authority of section 404(k)(5)(A) a “tax evasion” label has
been placed by the Commissioner and/or by the Government on
redemption dividends and claimed deductions under section
404(k)(1) relating thereto have been disallowed: First, in the
litigation of Boise Cascade Corp. v. United States, 329 F.3d 751
(9th Cir. 2003); second, by issuance of Rev. Rul. 2001-6, 2001-1
C.B. 491; third, in the litigation of Conopco, Inc. v. United
States, 100 AFTR 2d 5296, 2007-2 USTC par. 50,582 (D.N.J. 2007);
fourth, in the litigation of General Mills, Inc. v. United
States, 101 AFTR 2d 550, 2008-1 USTC par. 50,141 (D. Minn. 2008);
fifth, in the instant litigation; and sixth, in final regulations
promulgated in 2006 under sections 162(k) and 404(k), see secs.
1.162(k)-1(a), 1.404(k)-3, Income Tax Regs.
Under section 404(k)(5)(A) in 2001 the Commissioner issued
Rev. Rul. 2001-6, supra.2 Certainly, the Office of Chief Counsel
advised the Commissioner and was the primary drafter of Rev. Rul.
2001-6, supra. The revenue ruling, however, clearly was issued
by the Commissioner as are all revenue rulings to whom the
Secretary has delegated such authority as reflected in Treas.
Dept. Order 150-10 (April 22, 1982). See sec. 7803(a).
2 Sec. 7701(a)(11)(B) defines “Secretary” as “the Secretary of the Treasury or his delegate.” - 27 -
Letter rulings and technical advice memoranda are issued by
the Commissioner’s Office of Chief Counsel. That office,
however, only drafts and proposes revenue rulings and revenue
procedures. See IRS Deleg. Order 190 (Rev. 4, Oct. 8, 1996),
Internal Revenue Manual (IRM), pt. 1.2.53.5, (Oct. 8, 1996); Gen.
Counsel Order 4 (Jan. 19, 2001), IRM pt. 30.2, Exhibit 30.2.2-6
(Aug. 11, 2004); see also sec. 7803(b)(2)(B).
Rev. Rul. 2001-6, supra, was approved and issued by the
Assistant to the Commissioner, acting on the Commissioner’s
behalf, and was published in the Internal Revenue Bulletin, 2001-
6 I.R.B. 491, the authoritative publication of the Commissioner
for announcement of official rulings pertaining to internal
revenue matters. See sec. 601.601(d)(1), Statement of Procedural
Rules (“The Internal Revenue Bulletin is the authoritative
instrument of the Commissioner for the announcement of official
rulings, decisions, opinions, and procedures, and for the
publication of Treasury decisions, Executive orders, tax
conventions, legislation, court decisions, and other items
pertaining to internal revenue matters.”); see also id. sec.
601.601(d)(2)(ii)(a), (vii)(a) and (b).
Also in 2001 Congress addressed the section 404(k)(5)(A) and
by amendment clarified the Secretary’s authority thereunder by
adding the word “avoidance”. Economic Growth and Tax Relief - 28 -
Reconciliation Act of 2001, Pub. L. 107-16, sec. 662(b), 115
Stat. 142.
I would note that the Commissioner’s disallowance of
deductions under section 404(k)(1), based on the discretion given
to him in section 404(k)(5)(A), need not involve an analysis and
findings of “badges of fraud” typically associated with
prosecutions under section 7201 of affirmative attempts by
taxpayers to engage in willful tax evasion and with
determinations of willful civil tax fraud penalties under section
6663. See, e.g., Spies v. United States, 317 U.S. 492, 499
(1943).
Indeed, in this case petitioner filed its corporate Federal
income tax returns for 1994 and 1995 without claiming deductions
for redemption dividends. At this time no underpayments of tax
are associated with the claimed section 404(k)(1) deductions.
Not until December 9, 2003 (2 years after Rev. Rul. 2001-6,
supra, was issued), did petitioner file (via its second amendment
to petition herein) claims for refund for 1994 and 1995, asking
respondent and this Court to consider the deductibility of
petitioner’s redemption dividends and if allowed to refund
overpayments of taxes paid. There are no “badges of fraud” to be
found here, and respondent does not contend otherwise. Rather,
respondent simply contends that allowance of petitioner’s claimed
redemption dividend deductions would be improper and would give - 29 -
rise to underpayments of Federal income taxes which the
Commissioner, exercising his discretion under section
404(k)(5)(A), has described as tax evasion.
The tax “evasion” or “avoidance” label placed by the
Commissioner on redemption dividends under the authority of
section 404(k)(5)(A) is somewhat analogous to the tax “evasion”
or “avoidance” label that the Commissioner occasionally places on
transactions under the authority given to him in other Code
sections. For example, in section 269 the Commissioner is given
substantial discretionary authority to label a transaction as
engaged in for the principal purpose of tax evasion or avoidance
and to disallow related deductions. The tax “evasion” or
“avoidance” which the Commissioner typically identifies under
section 269 refers to the underlying nature and purpose of the
transaction, not to what we typically consider “badges of fraud”,
such as a taxpayer’s double set of books, destruction of
evidence, or omitted income. The tax evasion or avoidance
typically involved under section 269 may be described simply as
involving a transaction in which a taxpayer is attempting to
secure a tax benefit which it “would not otherwise enjoy” and
which the Commissioner, in his discretion, has identified as - 30 -
having a principal tax evasion purpose. See Southland Corp. v.
Campbell, 358 F.2d 333, 336 (5th Cir. 1966).3
Here respondent has labeled redemption dividends as
transactions that inherently provide to a corporate ESOP sponsor
tax deductions to which it is not entitled. In Rev. Rul. 2001-6,
supra, it is explained that the allowance of deductions for
redemption dividends would give corporate ESOP sponsors
deductions for payments that do not represent true economic costs
and that redemption dividends vitiate important rights and
protections for recipients of ESOP distributions.
In spite of the brevity of the explanation provided in Rev.
Rul. 2001-6, supra, I believe that in the light of section
404(k)(5)(A) the tax evasion label that has been placed on
redemption dividends by the Commissioner is entitled to
substantial deference. See Chevron U.S.A., Inc. v. Natural Res.
Def. Council, Inc., 467 U.S. 837 (1984). While notice-and-
comment rulemaking generally assures Chevron deference for
regulations, the absence of such formality in the issuance of
rulings does not preclude such deference where Congress intended
to grant the agency the power to make rules with the “force of
law” and “the agency interpretation claiming deference was
3 I emphasize that the sec. 404(k)(5)(A) authority to disallow a claimed sec. 404(k)(1) deduction because it would constitute a tax evasion transaction is even more specific than the authority set forth in sec. 269. - 31 -
promulgated in the exercise of that authority.” United States v.
Mead Corp., 533 U.S. 218, 226-227 (2001); see Barnhart v. Walton,
535 U.S. 212, 221-222 (2002).
Lastly, as stated, in 2006 the Secretary promulgated final
regulations reflecting the position set forth in Rev. Rul. 2001-
6, supra. See sec. 1.162(k)-1, Income Tax Regs.; sec. 1.404(k)-
3, Q&A-1, Income Tax Regs. (“Payments to reacquire stock held by
an ESOP * * * used to make benefit distributions to participants”
are not allowed under section 404(k)(2) and (5)). Although the
regulations apply only prospectively and only to amounts paid or
incurred after August 30, 2006, secs. 1.162(k)-1(c), 1.404(k)-3,
Q&A-2, Income Tax Regs., the regulations are relevant as they are
consistent with Rev. Rul. 2001-6, supra, see Smiley v. Citibank
(S.D.), N.A., 517 U.S. 735, 744 n.3 (1996) (“Where * * * a court
is addressing transactions that occurred at a time when there was
no clear agency guidance, it would be absurd to ignore the
agency’s current authoritative pronouncement of what the statute
means.”).
For the reasons stated, I would address respondent’s
alternative argument and conclude that respondent’s
determination--that the claimed deductions for redemption
dividends, if allowed, would constitute impermissible tax
evasion--should be sustained.