UNITED STATES v. DAVIS

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Argument of Griswold

Chief Justice Warren E. Burger: Number 282, United States against Davis.

You may proceed whenever you're ready Mr. Solicitor General?

Mr. Griswold: May it please the Court, this is a tax case what we might call a regular tax case, not a criminal case nor a land case as the last two were which comes here on a writ of certiorari to the Court of Appeals for the Sixth Circuit.

The basic factual situation is simple, the statutory provisions are somewhat complex but I think reduced to a relatively simple problem.

The case arises with respect to a family corporation which was set up in 1945 by Mr. Davis, the taxpayer here and his partner, Mr. Bradley.

At that time, Bradley had 50% of the stock and Davis had 25% and Davis' wife had 25%.

They sought to barrow $95,000.00 from the Reconstruction Finance Corporation or a subsidiary of it but found that they could do so only if the company had more capital.

Bradley was unwilling to increase his investment and so it was worked out by Davis acquiring $25,000.00 in preferred stock from the company for which he paid cash.

Some years later, Davis purchased Bradley's stock and transferred it in equal shares to his son and to his daughter.

As a result of this transaction, the stock was held four ways and Davis owned 25%, his wife 25%, his son 25%, and his daughter 25%.

And Davis himself owned all of the preferred stock.

In June 1963, the RFC loan was finally paid off and thereafter on October 1, 1963 pursuant to a corporate resolution, Mr. Davis turned in his preferred stock and received $25,000 from the corporation, and this is the transaction which is at issue here.

Justice Potter Stewart: Is there any question as to whether or not the time of the redemption of the preferred stock, there were earnings and profits?

Mr. Griswold: No, there's no question about that Mr. Justice, there were adequate earnings and profits to cover this.

The question is whether under the applicable provisions of the statute, the $25,000.00 is taxable as a dividend or whether it was received in exchange for the preferred stock resulting in no tax, since the amount received, $25,000.00 was the same as Mr. Davis' basis for the preferred stock.

Before going further, I would like to make it plain that this is simply a matter of construing a rather specific and somewhat intricate statute.

There is no suggestion of tax avoidance or that Mr. Davis set up any sort of scheme for artificially reducing his taxes.

The fact is that he received $25,000.00 from the corporation and that he turned in his preferred stock.

The question is what the tax consequences of this were and the circumstances of this case and under the applicable statutory provisions.

It's clear I think that this is a situation where Congress had power under the Sixteenth Amendment to impose a tax.

For that purpose, the basic fact is that $25,000.00 was separated from the corporation and was received by Mr. Davis to which I may add as indicated in my response to Mr. Justice Stewart that the corporation had earnings and profits and at least that amount.

This is not a case like Eisner and Macomber, the stock dividend case where the taxpayer received only pieces of paper and ended with more pieces of paper representing exactly the same interest that he had before.

Here, the shareholder received cash and had fewer pieces of paper than he had before that receipt, and the question is how the receipt of the cash is to be treated for tax purposes.

Basic to the consideration of that question is the provision of Section 318 of the Internal Revenue Code which is set out at pages 43 and 44 of the Government's recovered brief insofar as it is relevant to this question.

This is one of the two key provisions in the statute and I think that I should read it.

Section 318 at the bottom of page 43 of the Government's brief.

For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable 1 (a), an individual shall be considered as owning the stock owned directly or indirectly by or for his spouse other than a spouse who is divorced or under a decree of separate maintenance which is not applicable here, and two, his children, grandchildren and parents.

Now, under this statute, Mr. Davis “shall be considered” not maybe or improper circumstances but “shall be considered” as owning all the stock of the corporation, every share, all the common and all the preferred.

Justice Potter Stewart: What is it, that statute really, this attribution provision really means what it says if by –-

Mr. Griswold: Mr. Justice Stewart, --

Justice Potter Stewart: --assume the father is 75-years old and the son 50-years old and they hadn't seen each other for 30-years, and one lived in Europe and the other lived in California, is it supposed there's still be attribute?

Mr. Griswold: Yes Mr. Justice because I think the very purpose of the statute is to remove the questions of degree which could be raised by that kind of questions.

It is true that some lower courts have said that Section 318 should not be applied where there is evidence of active hostility between the parties, that is not an issue here, there is no trace of evidence of hostility here but I would take the ground that Congress felt that this was an area which should not be determined by the facts in each particular case, are they really friendly and so on as to which there can be infinite variation but that its language as written should be taken as written.

Justice Potter Stewart: And you don't think children -- I mean minor children or anything like that

Mr. Griswold: No, I'm sure that that does not apply.

It covers parents too so it's obviously not limited to minors.

One can say if he want to but he didn't owned all the stock, some was owned by his wife, his son and his daughter, but the fact is that Congress had said specifically that the tax consequences of what was done here shall be determined by treating him as the owner of all of the stock.

And for this purpose, I think that those last three words at the very bottom on page 43 shall be considered without qualification, are significant.

No suggestion is made either by the counsel for the respondent or in the courts below that the provision is not valid and I know of no basis on which such a contention could be successfully made.

This is the way the congress said that tax consequences of this sort of a payment out of a corporation should be determined.

So, we start with the proposition that Mr. Davis is to be treated as owning all of the stock of the company from which he received $25,000.00.

Let me point out next that Section 318 (b) which is about four inches below the top of page 44 and set out on page 44 of our brief specifically refers to Section 302 as being one of the provisions to which Section 318 applies.

That is a cross reference of provision but it says for provisions to which the rules contained in subsection (a) applies (c) (1), Section 302 relating to redemption of stock.

Let us then turn to Section 302.

This is a long provision beginning on page 39 of our brief, we have set it out in full there but most of it, the appellee is not applicable here.

The relevant portions are relatively simple of Section 302 (a), 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.

Now, what that means is that if you can bring yourself under paragraph (1), (2), (3), or (4), then it will be treated as a capital transaction and not as a dividend, and the first one of those four paragraphs, 302 (b) (1), subsection (a) shall apply if the redemption is not essentially equivalent to a dividend.

Now, actually can refer to subsection (b) (2), (3) and (4), only to say that everyone agrees that they are not applicable.

302 (b) (4) relates to stock issued by railroad corporations and reorganizations.

302 (b) (2) relates to a substantially disproportionate redemption of stock and 302 (b) (3) relates to a redemptions which terminates the shareholder's interest and it is entirely agreed that (2), (3), and (4) are not applicable and this case turns on the construction of Section 302 (b) (1).

We may complete the statutory picture though there is no controversy about it in this case by referring to Section 301, which provides that if Section 302 does not apply, and we contend that it does not, the distribution shall be treated as a dividend to the extent that it is a dividend under Section 316, which means essentially whether there are earnings and profits and Section 316 says that it is a dividend if there are earnings and profits, the statutory path is, shall I say disorderly and complicated but I think it is relevant, relatively clear.

It's relevant I think that there is nothing in these statutory provisions about business purpose or about tax avoidance.

These are simply a straight forward series of provisions designed to say that in certain circumstances, a payment made by a corporation to a shareholder is to be treated and taxed as a dividend.

As I've indicated when we go through all these statutory provisions, we find that the key passage, the clause on which everything turns is Section 302 (b) (1).

It's awkwardly stated I agree.

Its meaning becomes clearer I think if we reverse the negatives, then it would say subsection (a) which would treat it as a capital transaction shall not apply if the redemption is essentially equivalent to a dividend.

Now, what it says is that subsection (a) shall apply if the distribution -- if the redemption is not essentially equivalent to a dividend that puts it backwards I think and to me it's clear and I don't think it alters the meaning of particle.

If it says that subsection (a) shall not apply, if the redemption is essentially equivalent to a dividend.

Either way, the question which we must consider is whether this redemption in this case under the circumstances and the statutory provisions was essentially equivalent to a dividend, and it's our contention that the transaction here was in the light of the attribution rules of Section 318, essentially equivalent to a dividend.

It was the payment of money out of a corporation to the person who under Section 318 is to be treated as owning all of the stock of the corporation without any change whatever in his proportionate interest in the corporation since he is taxed on the basis that he owned all of the stock of the corporation, before the payment, and owned all of the stock of the corporation after the payment.

Such a payment by a corporation to a shareholder without any change in proportion and interest is, we submit, under many decisions of the Courts essentially equivalent to a dividend.

Section 302 (b) (1) is the linear descendant of a provision which goes back to 1921, when it was first enacted at that time, it was applicable only to stock which had been issued as a stock dividend and it was a part of the aftermath of Eisner and Macomber, the great scheme at that time was that you declared a preferred dividend on your common stock and then you immediately redeem the preferred dividend and the theory was that that wasn't taxable and the statute passed in 1921 was designed to reach that type of the situation.

It was soon found however that it wasn't limited to that kind of a situation, you could organize a corporation with serial preferred stock and then redeem the preferred stock year by year and seek to get around it and I make it, I repeat again, there is no suggestion that there was any tax avoidance scheme whatever involved in this case.

In 1926, the statutory provision was expanded to recover redemptions without regard to the origin of the stock, however, that provision which became Section 115 (g) (1) of the internal revenue code was worded somewhat differently than the present provision.

It made a redemption taxable as a dividend if it was made “at such time and in such manner” as to make the distribution and cancellation or redemption in whole or in part essentially equivalent to the distribution of a taxable dividend.

It was probably because of those words “at such time and in such manner” that some of the lower courts used concepts of business purpose and tax avoidance in construing that statute.

They said, well if there was a legitimate business purpose or if there was no scheme of tax avoidance, then it was not at such time and in such manner but there are no such words in Section 302 (b) (1) of the 54 code which is the provision now before the Court.

We have here the simple question whether the payment was essentially equivalent to a dividend.

The taxpayer wants to treat this payment as if it were payment of a debt.

He says he always understood that it would be paid off, his position is made clear at page 3 of his brief in opposition in this case from which I read two sentences.

Here moreover, there was a clearly identifiable date as of which the preferred stock was to be redeemed, the date of payment in full of the RFC debt.

In this respect, the preferred stock was like a subordinated debt, but there was no debt, there was preferred stock.

This was a payment with respect to stock which under the attribution rules did not in any way affect the proportionate ownership in the corporation which for tax purposes in pursuant to the expressed provision of the statute which represented Congress's statement as to how transactions of this kind should be treated for tax purposes.

For tax purposes, his ownership was 100%, both before and after the transaction.

Nor could this be treated as a partial liquidation of the corporation, for that requires some contraction of the business of the company.

Here, there was no contraction of the business.

There was simply the payment of $25,000.00 to the person who by the clear and expressed provisions of the taxing statute is to be treated as the sole shareholder in the company.

Thus, business purpose is we submit irrelevant.

Moreover, though there clearly was a business purpose for issuing the preferred stock, there was no such purpose for its redemption as the taxpayer himself testified in his deposition on page 17 of the record, this was surplus money.

The transaction was carried out for the benefit of the Mr. Davis and not of the company.

The distribution of surplus money to the sole shareholder of a corporation is precisely the kind of distribution to which the dividend rules of Section 301 and 316 are designed to apply.

Surely, that would be the result if no stock had been surrendered but Eisner and Macomber teaches that the presence or absence of pieces of paper representing the same proportion that enters in the corporation is irrelevant for tax purposes.

Here, the important fact is that under the provisions of the taxing statute, Mr. Davis owned all of the stock of the corporation before the transaction and he owned all of the stock of the corporation after the transaction.

The only substantial difference was that he had received $25,000.00 from the corporation.

Justice Potter Stewart: Mr. Solicitor General, would it make a difference if the $25,000.00 transaction would be taken in the form of a note?

Mr. Griswold: Yes Mr. Justice, I think that if he had lent the money to the company and if the circumstances were such that the note would not be held to be essentially an equity in this month and a subordinated capital, it would have made a difference?

Justice Potter Stewart: On this factual situation.

Mr. Griswold: On this factual situation, it seems to me it would have been somewhat difficult for the Government to contend that a note for $25,000.00 was not legitimate debt.

Justice Potter Stewart: But the -- he wouldn't gotten involved either because I think if the condition was that he put his money for the rest of the business.

Mr. Griswold: It would have had to have been a subordinated note, a note subordinated to the RFC's claim.

Justice Potter Stewart: I thought, at least at the risk of the business.

Mr. Griswold: As I understand it, he would have got the, could have got the loan by making a loan to the company.

It would not have had as good a balance sheet and would not have been as attractive for other creditors, was only needed to deal after the RFC and if he made it subordinate to all indebtedness, then I think the Government would surely have come in and said that this is not a debt but is a stock.

When I said that it would have been legitimate, I was thinking of subordination only to the RFC.

Justice Byron R. White: In the light of the facts of this particular case?

Mr. Griswold: On the facts of this particular case, if it was subordinate only to the RFC, it seems to me the Government might have had some difficulty in contending that this was equity rather than a dead investment.

It would have had some other consequences.

There is -- the fact of course here is that it is not a debt and was not claimed to be a debt and we do not think that it can be given the consequences of a debt in that transaction, whatever in that situation, whatever might be the consequences if there had in fact been a note rather than a stock.

In the decision below, and in other cases and in the briefs here, there's talk about the Net Effects Test and the strict Net Effects Test and the Flexible Net Effects Test and I find these phrases confusing and perhaps question begging.

My own view is that they are irrelevant.

There is no such provision in the statute and the application of the statute becomes unnecessarily complex and confusing if resort -- if resort is made to such terms in the analysis of the problem.

The basic and underlying situation here is that Congress has provided that a person in Mr. Davis' situation is to be treated as the owner of all of the stock for the purpose of determining how he is to be taxed on the $25,000.00 which he undoubtedly received from the corporation which had earnings and profits and at least that amount.

Justice Hugo L. Black: What is your judgment as to the standard necessary to determine the case under?

Mr. Griswold: Standard as necessary to determine?

Justice Hugo L. Black: Yes.

Mr. Griswold: Determine what Mr. –-

Justice Hugo L. Black: Whether it is the equivalent of a guilt?

Mr. Griswold: I think in this case, I would say that the standard is what would have been the case if he had surrendered nothing?

If he had simply owned stock at the beginning and had received $25,000.00, no one would question that the $25,000.00 was a dividend.

Now, the mere fact that he gave up a piece of paper not affecting his proportionate interest in the corporation, does not keep that from being essentially equivalent to a dividend.

As the owner of all of the stock is proportionate interest and the corporation did not change a particle as a result of the transaction, he owned it all before, he owned it all after, but when it was completed he had $25,000.00 in his own hands which he didn't have before.

We say that that was a dividend.

As I have suggested in replying to Mr. Justice Black, if he in fact owned all of the stock himself, there could be no doubt.

I suggest that the $25,000.00 was taxable to him as a dividend since his proportionate interest was in no way changed and the presence or absence of pieces of paper in no way affected the substance of the transaction and the statute says that in his situation, he is to be taxed on the basis that all of the shares are attributed to him.

I've said that I think that Section 302 (b) (1) is the key here, of course, it's equally plain that Section 318 is important.

If the Court says as I think it should that Section 318 means what it says and that Congress intended it to mean what it says and intended not to have individual factual inquiries on a general equitable basis in the construction of 318, then I think that the consequence for which we are contending follows.

It may be somewhat literalistic but this is an area it seems to me where the tax statute can well be construed the way it is written in order to both to minimize repeated detailed factual inquiries into the circumstances of particular cases with no standard set up by Congress and in order to clarify the application of the tax law.

It may or may not have been a wise provision for Congress to make, I think experience shows that it was necessary and useful, but it is the provision that Congress did make and it should be applied here.

And accordingly I submit that the judgment of the Court of Appeals should be reversed and the case remanded to the District Court with instructions to dismiss the complaint.

Chief Justice Warren E. Burger: Thank you Mr. Solicitor General.

Mr. Waller?

Argument of William Waller

Mr. William Waller: Mr. Chief Justice and may it please the Court.

There is a old English saying about not being able to see the wood for the trees and it seems to me that that is applicable here.

The Solicitor General's argument here would be exactly the same if on yesterday Mr. Davis had bought $25,000.00 of preferred stock from this corporation and today had sold it back and got his money back.

Now, true, he has given up only a piece of paper but he's got back exactly the amount of money that he put out.

He put out $25,000.00 and got the piece of paper, now he gives back the piece of paper and gets the $25,000.00.

And I respectfully disagree with the Solicitor General that Congress has power under the Sixteenth Amendment even if it wanted to, to say that that is taxable income.

I don't think Congress intended any such result but if Congress had intended such a result, I think that Eisner versus Macomber teaches that that would not be treated as an income or deem no more than if a race horse were involved if you, for the race horse –-

Justice Hugo L. Black: What would it be treated as?

Mr. William Waller: Treated as a return of capital.

Justice Hugo L. Black: You mean as a sale?

Mr. William Waller: A sale, that's what this was, a sale of stock to the corporation but the minutes provided, the director's minutes that Mr. Davis offer the sale of stock back to the corporation, $25,000.00, the offer was accepted, the stock was bought, the stock was redeemed, so everybody was in exactly the same position after the transaction, great taking the transaction as a whole, the two poll of the transaction.

Mr. Davis was in the same position.

The corporation who had this temporary capital which he had needed in order to get the RFC loan, when the RFC loan was paid off as had been intended all the time, the stock was redeemed, the corporation did not need the $25,000.00 as the Solicitor General states, it was surplus money, the preferred stock was 6% preferred stock, this was 1963 when preferred, when 6% was a good even money in any normal Board of Directors.

Having $25,000.00 that was not needed in the business, having 6% preferred stock outstanding would have redeemed the preferred stock.

It was for the benefit of the corporation.

It may have been that Mr. Davis, he probably did wanted this $25,000.00 back since the purpose for which he had returned it into the corporation had been served but he is at the end of this two prong transaction exactly where he started, with his money back, that is a classic example of a return of capital and not of a dividend.

As I have stated, if the two transactions had occurred one day after the other one.

According to the Solicitor General's argument, this would be a dividend merely because of the existence of earnings and profits.

Justice Byron R. White: What would you say if one partner decided to put up all the money they needed for the new plant itself?

They needed a new plant, the other partner said no, I can't put up any more money but I'd like to keep half ownership, the other one said, well, I'll put it up the preferred stock, so he puts up a $100,000.00 preferred stock, they build a new plant, they accumulate some money and they redeem as preferred stock later, what would you do?

Would you say you get the same result?

Mr. William Waller: I say that's a return of capital also, that's a return of capital.

I don't think it's a bit difference and if had been a subordinated?

No.

Justice Byron R. White: Of course he deliberately chose to --

Mr. William Waller: Yes.

Justice Byron R. White: --put it up in his preferred stock and to, and to put it in the risk of the business rather than making any subordinated note.

Mr. William Waller: Well, a subordinated note would also have been at the risk of the business if it was subordinated as the usual subordinated note is, that is to -- to the RFC loan, to bank --

Justice Byron R. White: The preferred --

Mr. William Waller: -- bank debts and --

Justice Byron R. White: Nevertheless, would it be shown as a liability?

Mr. William Waller: Oh yes, yes it would, that's true.

Justice Byron R. White: And he preferred not to have that stock --

Mr. William Waller: He preferred not to do it because that made the balance sheet better for all the business purposes in general.

In other words, you didn't have that debt.

On the balance sheet, it was all, appeared to be equity capital for it was.

Now, there have been a number of cases where this very same thing happened in the lower courts and uniformly held for the taxpayer that where there was a temporary advance of equity capital to a corporation for a limited purpose and for a limited time with the understanding that it would be -- that the stock would be redeemed, when that purpose had been served, that that is a return of capital they have used therefore is business purpose.

Now, I think one Court did say and the Solicitor General has used the argument that while there's a business purpose in issuing the stock in the first place that the redemption of the stock is not a business purpose but I don't think you can view the entire transaction of this kind as in isolation, view the redemption in isolation probably original issuance of the stock.

The transaction should be viewed as one transaction or two prongs, as I have stated of a transaction.

Now, I will have to agree that this net effect test is irrelevant.

I believe the Solicitor General advanced that thought.

The reason, the net effect test or the strict net effect test I think has come into play was largely because of the case that Mr. Griswold tried when he was in private practice, they bet for the state case in which this Court reversed the Second Circuit.

Whereupon, the Second Circuit Court of Appeals in the bet for the state case had nothing to do with the stock redemption, it involved booth in a reorganization case and the Second Circuit had held that this booth was a return of capital and not a dividend.

This Court held that it was a dividend under the provision of the statute which used the words effect.

Whereupon, the Second Circuit Court of Appeals -- the Supreme Court has now reversed all of our earlier decisions in redemption cases.

So from now on, the Second Circuit has followed what they call as Strict Net Effect Test saying that the Bedford decision had overruled our prior decision when it didn't do any such thing.

And even as late as the Levin case last year, year before last, the Second Circuit Court of Appeals repeated this statement, that the Bedford case had overruled their prior decisions where they had followed the same or a different rule regarding redemptions.

The Seventh Circuit in the (Inaudible) case which is cited in our brief pointed out very clearly that the two situations are entirely different.

Now, the legislative history of this Section 302 (b) (1) states specifically as it could be stated that what Congress was intending to do in 302 (b) (1) was to revert in part to existing law under the Section 115 (g) of the old 1939 Government.

So, Congress said, the Senate Committee said that they were restoring that to the house bill which it left out the essentially equivalent test and they were restoring this essentially equivalent to a dividend test for the purpose of going back to existing law so that a taxpayer who could not come within one of these so called safe harbor provisions of the new code, the ones that we agree are not applicable here.

They could not come within one of them.

He could still rely on the fact that his redemption was not essentially equivalent to a dividend.

Nothing can be planned out it seems to me than the statement in the statement several times in the senate committee report that that was what was being done.

The original house bill had left out this essentially equivalent test and it only provided these mechanical tests based on ownership of stock.

The questions -- the provisions being that if the shareholder's interest was terminated or if there were disproportionate redemptions, he could by following these technical rules escape dividend treatment.

Now, those safe harbor provisions all referred to ownership of stock and the house bill had in it.

These attribution rules which that said should be followed in the determining the ownership of stock.

Well, the Senate Committee kept that provision about determining the ownership of stock, the attribution rules for determining the ownership of stock but then puts back into the new 1954 code, the old 1939 provision about essentially equivalent to the dividend.

We say that these attribution rules were not intended by Congress to apply to the essentially equivalent to a dividend test.

They were intended to apply for the purposes of determining ownership in those provisions where ownership of stock was mentioned and there was no mention of ownership of stock in Section 302 (b) (1).

So, while the lower courts said no this Section is pretty wrong, they said for the purposes of this section, we'll say that the attribution rules apply but even though they do apply, this particular redemption is okay because of the business purpose rule and in one place, in one respect, I think I must agree whole heartedly with the Solicitor General and that is that these attribution rules either apply or they don't apply.

You can't say that they apply where a father and son love each other but they don't apply where they are estranged or where a man and his wife are estranged or where a partner and his partners, a partnership and partners are estranged, that would create interminable difficulty in finding out when the attribution rules do apply and when they don't apply.

But I say they don't apply at all with respect to Section 302 (b) (1) because that was the old test from the 1939 code where there were no attribution rules.

And in every statement in the Senate Committee report saying what they were trying to do, it was specifically stated that they were reverting to existing law with no qualification based on these attribution rules.

So, --

Justice Potter Stewart: I haven't followed this part of your argument Mr. Wallace that you say that the attribution that Section 318, attribution provision do not apply to this case?

Mr. William Waller: Do not apply.

Justice Potter Stewart: And why is it?

Mr. William Waller: Alright, I'll say it for this reason Your Honor.

The Section 318 I think is ambiguous in this respect because it says that Section 318 (a) shall apply in determining the ownership of stock for purposes of this section.

Now, I would have to agree that if we didn't have any legislative history and we didn't have any question of constitutional doubts raised that probably one would say it applied for the purposes of the old section including 302 (b) (1).

But if you look at the sequence of events by which this particular section got in to the 1954 code, I think it's perfectly plain that what Congress was saying was that these attribution rules should apply in determining the ownership of stock for the purposes of these provisions of the section where ownership of stock is mentioned, namely, Section 2 and Section 3 but not Section 1, I mean subsection 1 of Section 302.

Justice Potter Stewart: Now, I'm looking at pages 43 and 44 of the Government's brief.

Mr. William Waller: Yes sir.

Justice Potter Stewart: In which –-

Mr. William Waller: Look at page 41 in the middle of the page, constructive only surplus stock, except as provided in paragraph two of this subsection, Section 318 (a) shall apply in determining the ownership of stock for purposes of this Section.

Now, I say that you should emphasize the words the ownership of stock because in the other provisions of Section 302, the ownership of stock is mentioned, whereas in the essentially equivalent provision, there is no mention of ownership of stock and ownership of stock is considered only by virtue of judge made rules and not because of any statutory provision.

Justice Potter Stewart: But the, going back to 43 and 44 in pages and then look at 318 (b) on 44, the provision to which the rules contained in subsection (a) applies to Section 302 relating to redemption of stock, and that it would apply that you'd suppose to see the whole section?

Mr. William Waller: Well yeah, and that's why I, that's why I have just raised.

Justice Potter Stewart: That is not inconsistent I suppose with your argument.

Mr. William Waller: That's what I've been reading, yes.

Justice Potter Stewart: It should be read as applying only to those parts of the section that referred exquisitely to ownership of stock.

Mr. William Waller: Yes, that's my point.

And I say the sufficient ambiguity in the language that we can go to the senate committee reports to find out what they meant and when we do go to the senate committee report, I think it's best to explain that Congress did not intend the attribution rules to apply when determining whether a redemption is essentially equivalent to a dividend.

Justice Potter Stewart: Has any Court ever accepted this argument which you're making?

Mr. William Waller: Well, no Court has accepted it whole heartedly, they have only said we think there ought to be exceptions where this family and strange one and other things like –-

Justice Potter Stewart: Well, that's not your argument to hear at all?

Mr. William Waller: I agree with the Solicitor General that the veto applies, it didn't apply but I say it doesn't apply and he says it does apply.

Justice Hugo L. Black: Where is the history, legislative history in your brief to which you refer –-

Mr. William Waller: Yes –-

Justice Hugo L. Black: --by that argument?

Mr. William Waller: My brief –-

Justice Hugo L. Black: Page what?

Mr. William Waller: Starting on page 10, well, there's a part of it, the main part of it is yes, pages 10 and 11.

Then if there, it's referred to all through the brief, it's a very short brief if Your Honor please, and it's referred to again on page 14.

Justice Hugo L. Black: Are you having this as though the man had just loaned the money for the company?

Mr. William Waller: I'm not arguing that he just loaned it, no Your Honor.

I'm saying that it was a purchase of preferred stock by Davis.

Justice Hugo L. Black: They purchased a preferred --

Mr. William Waller: Purchased or preferred stock from the corporation --

Justice Hugo L. Black: With an agreement that they would buy back?

Mr. William Waller: Agreement they would buy it back when the RFC loan was paid off.

It would redeem it, when the RFC loan is paid off.

That was the general understanding, it wasn't in the form of a written agreement but it was understood between all parties involved that this was a -- this was done solely for the purpose of getting the RFC loan.

Justice Hugo L. Black: Did the Court found out about that?

Mr. William Waller: Yes.

The Court found that.

Justice Hugo L. Black: That's what it found?

Mr. William Waller: Yes, yes.

Justice Hugo L. Black: On what page?

Mr. William Waller: Both lower courts.

Alright sir, in the appendix, the Court of Appeals opinion would be I think he quotes from the District Court, pages 40 --

Chief Justice Warren E. Burger: Against 39 doesn't it?

Mr. William Waller: Well, yes, but I'm thinking about the place, well, he quotes the, the Court of Appeals Court's on pages 45 and 46 of the appendix.

The subsequent acquisition of Bradley stockholdings by taxpayer making the redemption distribution essentially pro rata because of the Section 318 (a) attribution rules, neither in pairs the legitimacy of the purpose underlying the issuance of the preferred stock (to provide additional security required by RFC) now alters the fact that the redemption was simply the final (contemplated step taken in completion of this purpose).

Unknown Speaker: Then what did the Court of Appeal hold?

Mr. William Waller: They held with us that this was return of capital and not a dividend.

The District Court held it was a return of capital and not a dividend.

The Court of Appeals held that it was a return of capital and not a dividend and we are here seeking to sustain the decisions below.

Justice Thurgood Marshall: Mr. Wallace, any difference between the -- this being a note which we talked about earlier subordinate only to the RFC and being preferred stock.

Mr. William Waller: Well, I wouldn't say there was no difference because of course the note is different from preferred stock, there's a lot of consequences that attached to a note that do not attached.

Justice Thurgood Marshall: But you do –-

Mr. William Waller: But so far as this particular situation is concerned as to whether it's a return of capital or not, I say that's a return of capital

Justice Thurgood Marshall: Well, I mean as to this particular case, --

Mr. William Waller: Yes.

Justice Thurgood Marshall: If it had been a subordinated note, it would be under the dividend clause.

Mr. William Waller: If it had been a subordinated note, it would not have been that the return would not have been a dividend and the Solicitor General would not even have made such a contention as he stated a while ago.

He didn't quite go that far but he said --

Justice Thurgood Marshall: I don't think he went that far?

I don't think he went that far.

Mr. William Waller: He didn't go quite that far but write almost that far, he --

Justice Thurgood Marshall: I didn't hear him that way that's why we're trying to get your view.

Mr. William Waller: He said I don't think the government would have much case, that's what he said I think in the vernacular.

Justice Thurgood Marshall: Well, it's your position and there's no difference.

Mr. William Waller: I don't think for the purpose of this case that there's any significant difference Your Honor, that's correct.

Justice Thurgood Marshall: You mean if the owner of this corporation and given $25,000.00 to the corporation and then taking it back later will be no different from the fact that he issued it in stock.

Mr. William Waller: That's correct Your Honor.

In other words, as to return of capital in either event, what the man has done, he hasn't made any money.

Income is making some money.

Income under the --

Justice Thurgood Marshall: But he's got the same corporation with all of his assets and is also taking $25,000.00, he still got the whole total.

Mr. William Waller: He just got his own $25,000.00 back, he got back what he put in, in other words, he's just exactly where he was to start with.

Justice Hugo L. Black: No, how did he end up with common stock?

Mr. William Waller: If he'd put that, if he put that in common stock and if you leave this attribution rules out of it by, it would've been the same thing.

Justice Hugo L. Black: Well, I know but you say there are times not even with the attribution rule.

Mr. William Waller: I say and finally when even with the attribution rules.

Justice Hugo L. Black: Right and now could you?

Mr. William Waller: And I would say I would have a more difficult case if it were for a common stock than with --

Justice Byron R. White: Why, the RFC says you need $24,000.00, $25,000.00 more in equity, he says do you care if it's preferred or common?

They'll say no, we'll put up, he say well I'll put it up as common and when the moment is paid off, he says I didn't want my $25,000.00.

Mr. William Waller: Well, I think -- I think if there had been a clear cut agreement that it would be redeemed as soon as the RFC loan was paid off that I could substantiate the common the same way.

Justice Byron R. White: You really would --

Mr. William Waller: But I'd rather do it with the preferred.

Justice Byron R. White: But why, I don't see that there's any real difference in terms of your argument between common and preferred.

You have to argue for one as well as the other.

Mr. William Waller: Well, I'll have to go back -- I'll have to go back to the 1920 -- legislative history of the 1926 Act to explain that, because the -- in 1926, when the statute was amended, the -- it was apparent from the reports of the legislative committee's lab that what they had in mind was taxing a pro rata redemption of common stock, in other words, his, two people have got equal amount of common stock and he redeemed 10% of each one, well, that's essentially equivalent to a dividend.

But now of course that could apply here only by virtue of the attribution rules because without the attribution rules, Mr. Davis owned only 25% of the common stock.

His wife owned 25% and his two children who were ertainly not his dummy as in any way even though they may have been family solidarity as distinguished from estrangement.

They were the stock holders and they could have redeemed through the board of directors get to redeem this stock if Mr. Davis hadn't wanted it redeemed.

As far as that's concern, they could have outvoted him and redeemed the stock if he had not wanted it redeemed.

So, the -- it's not correct say that this redemption was strictly for the benefit of Mr. Davis, it was for the benefit of the corporation to get rid of a 60% preferred stock in 1963, it wouldn't be the day if anybody had some 6% stock outstanding to David want to keep it of course, but in 1963, the situation was entirely different, 6% --

Justice Hugo L. Black: Where did you get -- when was the money put in?

Mr. William Waller: The money was put in back in 1946 I believe it was, 45.

Justice Hugo L. Black: When was it taken out?

Mr. William Waller: 63.

Justice Hugo L. Black: 46 to 63?

Mr. William Waller: Yes, that's when the RFC loan wouldn't pay it off, it took a long time to pay it off.

Justice Hugo L. Black: Who was here or him by that transaction?

Mr. William Waller: The whole corporation was help back because --

Justice Hugo L. Black: The cost of money in that, it could be used as though they owned it?

Mr. William Waller: It was, yes, that's correct.

The corporation used this money all that time.

It had that for working capital all that time.

Justice Hugo L. Black: Then the man got it back?

Mr. William Waller: He got it back for his preferred stock, he got it back for his stock.

Justice Hugo L. Black: But the man himself didn't get anything did he?

Mr. William Waller: He --

Justice Hugo L. Black: Did he put a stock, let them have it use it and make it appear that they hadn't stock -- they had this much value when they didn't have it.

Mr. William Waller: Yes, they had it all that time.

Justice Hugo L. Black: Well, they headed in their profession but if it was with the understanding he'd get it back.

Mr. William Waller: Not until --

Justice Hugo L. Black: With the exact amount, what good did it do to the company?

Mr. William Waller: Well, because they had it all that time as working capital.

All the time that the RFC loan was outstanding, the corporation had it as working capital and it was redeemed only when the purpose had been served, when the RFC loan was paid off.

Justice Hugo L. Black: When was it paid off?

Mr. William Waller: 1963.

The loan was paid off in 63 and at that time shortly thereafter, the preferred stock was redeemed.

Justice Hugo L. Black: The company owe anybody else, anything?

Mr. William Waller: The company did not owe any body else anything and the testimony was that the corporation had never borrowed any money since then from any body.

In other words, it was surplus money as the Solicitor General has said.

They didn't need the money.

There it was, they didn't need it so they redeemed the 60 --

Justice Hugo L. Black: Your argument sounds to me like you're saying he actually made a conditional loan of a stock to the company?

Mr. William Waller: No, money, money Your Honor not stock, money.

Justice Hugo L. Black: Well, he actually -- he put money in there?

Mr. William Waller: Yes.

Justice Hugo L. Black: The same amount of money?

Then got exactly the same amount of money?

Mr. William Waller: That's right, so I say he didn't have any income, because that's not income, he didn't make anything.

Justice Hugo L. Black: But evidently he did, the company couldn't -- didn't the company make money during that time?

Mr. William Waller: Oh yes, oh yes, and his common stock became more valuable as a result of it and his wife's common stock and his children's common stock.

Justice Hugo L. Black: But by reason of his being fortunate or farsighted enough to get the --all kind of stock, he didn't loose it?

Mr. William Waller: He didn't loose anything else.

Thank you Your Honor.

Chief Justice Warren E. Burger: Thank you counsel, Mr. Solicitor General, do you have anything more?

The case is submitted gentlemen.

Thank you very much for your submission.