IVAN ALLEN CO. v. UNITED STATES

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Case Basics

Docket No.

74-22

Petitioner

Ivan Allen Co.

Respondent

United States

Decided By

Burger Court (1972-1975)

Opinion

422 U.S. 617 (1975)

Argued

April 15-16, 1975

Decided

Thursday, June 26, 1975

Term:

1970-1979
- 1974

Facts of the Case

None

Question

None

Argument

Ivan Allen Co. v. United States - Oral Argument

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Ivan Allen Co. v. United States - Oral Argument, Part 1

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Ivan Allen Co. v. United States - Oral Argument, Part 2

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Conclusion

Decision: 6 votes for United States, 3 vote(s) against
Legal provision: Internal Revenue Code

None

Print this transcript Transcript:

Argument of Scott P. Crampton

Chief Justice Warren E. Burger: We'll resume the arguments in Ivan Allen Company against the United States.

Mr. Crampton, you have 18 minutes remaining.

Mr. Scott P. Crampton: Mr. Chief Justice and may it please the Court.

I'd like to point out in continuing our argument that if the resources of this corporation had been entirely reflected in plant and equipment then there would obviously be no liability here for the unreasonable accumulation.

And I think counsel for the tax payer has agreed in his oral argument that the money that they invested in the Xerox stock is in fact extra money that the corporation really didn't need other than perhaps the $100,000.00 of cost.

Chief Justice Warren E. Burger: I suppose included in the first part of your statement would be land for example which is purchased for possible plant expansion if they could demonstrate a valid --

Mr. Scott P. Crampton: That's right.

Yes, I think anything if they can really firm it down that they plan to move the plant or expand it or do something like that they have a solid reasonably anticipated need that would qualify under the exemption.

Chief Justice Warren E. Burger: But if it was land they bought for speculation for arise in the market then would it fall in the same category in your view is the Xerox stock?

Mr. Scott P. Crampton: No, because it would not be a net liquid asset, it wouldn't be readily realizable.

I think they do make a distinction.

You have to look at what your current situation is and if you had it tied up in long term investments like that I don't believe any of the case to say that it would consider that.

Now, perhaps --

Chief Justice Warren E. Burger: It turns on liquidity then?

Mr. Scott P. Crampton: Yes.

I assume if they kept investing let's say hundreds of thousand of dollars and land just to perhaps a thought of avoiding this when maybe the commissioner might step in.

But basically they have been looking at liquid assets.

Justice Potter Stewart: Neither the statute under regulation saying anything about liquid assets?

Mr. Scott P. Crampton: No.

But I think the case law has pretty well developed that and that is the theory I think back of it is that if you have the money invested in such a way that you really can't get your hands on it then nobody could criticize you for not paying the dividends that --

Justice Potter Stewart: And yet --

Mr. Scott P. Crampton: -- otherwise it would be due.

Justice Potter Stewart: If the holder -- if the whole fulcrum of decision whether or not the assets would liquid, it seems to me that that would perhaps provide a bit many opportunities to violated the -- both the letter and the spirit of Section 532 if corporations should go off and buy Rembrandt portraits and things like that.

That would be and certainly an incorporated pocketbook wouldn't it?

Mr. Scott P. Crampton: I think so and that was why I qualified my answer to the Chief Justice that I thought that this became obvious.

The commissioner might very well move in.

You shouldn't just let them as you say by portraits or by land that they don't anticipate ever using at all.

But I think as a--

Justice Potter Stewart: Maybe, is there any decision of this Court that says that the test is whether the assets are liquid or easily convertible into cash?

Mr. Scott P. Crampton: The National --

Justice Potter Stewart: Nothing in either of the statute of regulations that say a word about that.

Mr. Scott P. Crampton: You're right but the National Grocery Company case that we mentioned earlier focused on the liquidity of the asset pointing out that the securities that were really liquid had dropped the value to $2 million and --

Justice Potter Stewart: And realized depreciation --

Mr. Scott P. Crampton: Yes.

Justice Potter Stewart: -- and that the Court in that case said that was a factor to be taken into consideration.

Isn't that -- that's about all it said, isn't it?

Mr. Scott P. Crampton: That's about right, yes.

Justice William O. Douglas: But in any event in this case the assets are liquid?

Mr. Scott P. Crampton: That's been stipulated and they are -- everybody knows Xerox stock is liquid and that is the principle asset that they had here.

Justice William H. Rehnquist: Well, how about the old French saying that everything has its price.

You know, you can take something that doesn't have a -- isn't traded on a market and yet presumably if you wanted to sell it you can sell it and if somebody wants to buy it they can buy it.

It's just a question of getting together on the price.

Mr. Scott P. Crampton: I think that's true but I think part of the answer to this problem of putting your securities or assets in long term investments are that probably the board of directors as a practical matter wouldn't want to do that because most corporations closely held.

They probably want to have their assets where they can reach them or readily convert them if they need to.

Justice William H. Rehnquist: Unless, it's an incorporative pocketbook?

Mr. Scott P. Crampton: That's right.

But even I think a lot of people incorporated pocketbooks may not want to put their money into land if they feel they couldn't get it out for 15 or 20 years and anywhere near they put it in.

But I do coming back to this case, I think we have stipulated that question out of the case and stipulated that we do have liquid assets here and as I say we can.

This corporation could realize -- could convert this of need to or borrow against that are utilize these assets to pay the dividends.

Justice William H. Rehnquist: Well, that's fine if liquidity is an important aspect of the test?

Mr. Scott P. Crampton: Well, I think it is and I think -- I mean that's what the cases of the lower courts that have considered this have held that time and time again.

Chief Justice Warren E. Burger: It's really limiting test isn't it when you consider that in certain periods land -- investment land could be a shelter that would be quite as liquid as Xerox stock with very high return certain areas of the country capital gains.

Mr. Scott P. Crampton: Well, that is true but I don't think that your land -- your problems with land usually I would say it's a practical matter much more complicated than they are with the securities on the New York Stock Exchange so up and even though you think you've got a great bargain in land you may have title problems or questions of state regulations zoning and things like that that complicates your life if you're putting your assets in the land.

But you certainly don't have those with listed securities.

Coming back to that National Grocery --

Chief Justice Warren E. Burger: In other words if --

Mr. Scott P. Crampton: Pardon me.

Chief Justice Warren E. Burger: I would interrupt you again.

Are you really saying that the liquidity test is something like making the comparison of whether the asset is in about the same shape as it would be if it were sitting in the bank?

Mr. Scott P. Crampton: Yes.

Chief Justice Warren E. Burger: In the bank, it would clearly be --

Mr. Scott P. Crampton: Readily available.

Chief Justice Warren E. Burger: -- subject to this penalty?

Mr. Scott P. Crampton: And it's --

Chief Justice Warren E. Burger: And you're saying that any asset which has essentially the same kind of liquidity as money in the bank, it is then subject to penalty provision?

Mr. Scott P. Crampton: It's subject to being considered in determining whether or not the reasonable needs of the business can be met from the available resources.

Justice Lewis F. Powell: Mr. Crampton?

Mr. Scott P. Crampton: Mr. Powell.

Justice Lewis F. Powell: Now, limiting to our discussion yesterday and having in mind that question by the Chief Justice as to stock being the equivalent in terms of liquidity with cash, what would you advise the corporation?

What would you have advised this corporation bearing in mind as I noted yesterday that Xerox stock varied according to one of the manuals from 35 to 134 last year?

What would you have advised this company at the beginning of the year on your theory of the law as to when to sell the stock or whether or to sell it?

And would you have advised the client that Xerox stock at a 134 was equivalent of cash when you dropped the 35 before the year was over?

Mr. Scott P. Crampton: No, I would, in answer your question, I think I would have suggested that the corporation look at that movement of the Xerox stock during the year.

And if they had bought it, I forgot what the price was per share of it in your example supposing they had bought it five and it never got below 35 and they had this type of earnings and they had this volume of shares so that they had if you use the value of 35, there were maybe two or three times above their earnings I would certainly suggest that either they declare their earnings as a dividend or do so realizing that they would risk a tax under the penalty provision here the accumulated earnings tax.

Justice Lewis F. Powell: You do that at the fiscal year?

Mr. Scott P. Crampton: No, I think you look at that the end of the year.

You would see where the movement has been during the year and I think that your bottom would be the lowest thing would be the factor that you would really consider if you want to be safe.

Justice Lewis F. Powell: So, on the last day of your fiscal year you take a look at the market value of the stock and I think you said yesterday you thought you could average it or take the low figure.

What would you do with your real estate that we talked about yesterday, would you get appraisals?

Mr. Scott P. Crampton: No.

Justice William O. Douglas: This is at various times during the year?

Mr. Scott P. Crampton: No, because I don't think the case say you take in to consideration real estate unless an example you gave me you could establish that it was readily marketable.

But here again, I think you look at what the assets are available for -- to pay the dividends.

Can you pay the dividends without disrupting a normal life of this corporation in the serious way?

And if you have liquid assets, the question is; why shouldn't the dividends be paid?

I would like to -- if I might just mention briefly the one statement from that National Grocery case that I think does state the position of this Court on the question.

It said depreciation and any of the assets is evidence to be considered in determining the issue of fact whether the accumulation of profits was an excess of the reasonable needs of the business.

And it's near as I know that quoted statement has never been questioned or repudiated.

And if you do look at depreciation in the assets then it seems to us that the economic test applies when assets are going down that you're certainly justified in looking at it when they go up.

The stipulation as we mentioned shows that this Xerox stock had a cost of $1,200.00 for the fiscal year 66 and it had a fair market values the party stipulated of almost $2.5 million so that that's 20 or 25 times the original cost.

The margin here is such that this corporation could certainly have paid the dividend of $344,000.00 that year without any substantial loss of economic muscles as we view the situation.

I was asked yesterday --

Justice Potter Stewart: If it would've had, in order to do that it would've had needed to sell part of the stock or borrow against it wouldn't it?

Mr. Scott P. Crampton: It might have, yes.

Justice Potter Stewart: If we're talking about liquidity, if we're talking about --

Mr. Scott P. Crampton: That's right.

Justice Potter Stewart: -- cash dividends.

Mr. Scott P. Crampton: Well, --

Chief Justice Warren E. Burger: I can use pay out dividends in time to could they not?

Mr. Scott P. Crampton: Yes, they could but to pay out -- if they paid out the Xerox stock it would come out at their cost and the tax payers would've picked it up market value --

Justice Potter Stewart: The market value.

Mr. Scott P. Crampton: -- and I think that that would've been -- they wouldn't do that as a practical matter.

I don't think --

Justice Potter Stewart: Although they did do it in the previous year, do they not?

Mr. Scott P. Crampton: Yes, just to a few shares.

Justice Potter Stewart: As to a few shares.

Mr. Scott P. Crampton: 870 I think.

I was asked yesterday about the considerations for accounting --

Justice Potter Stewart: Why would that be disadvantageous to do?

If the corporation paid it out any kind and under their regulation as its cost and at least would've been a realizable or taxable gain.

They would just to pay it out at cost and the shareholders would've received it at fair market value with fair market value as shareholders basis in the event of subsequent sale.

Why would that have been disadvantage economically?

Mr. Scott P. Crampton: Well, I believe the corporations would've -- had to pay a tax on to see the dividends at fair market value when they receive the shares.

Stockholders, pardon me, yes.

Justice Potter Stewart: At fair market?

Mr. Scott P. Crampton: At fair market value.

Justice Potter Stewart: That's ordinary income?

Mr. Scott P. Crampton: Yes.

Justice Potter Stewart: Would that be true of cash too?

Mr. Scott P. Crampton: That's right.

But if they distributed the stock they'd be picking up -- they get a $100,000.00 credit and pick up $2.5 million of ordinary income or as I don't think that the -- if the stockholders are using this corporation or concerned about it they would not probably want to pick up that kind of income in a one year.

Chief Justice Warren E. Burger: What if they paid out a million dollars of Xerox stock to the stockholders as dividends to the stockholders of their own company they say fairly substantial amount in commissions, would they not?

Mr. Scott P. Crampton: I think on a block that big the commission wouldn't be maybe 1% or 2%.

We have stipulated here I think it's 6% commission rate but that was being liberal.

Justice Potter Stewart: It's unrealistically high, I think.

Mr. Scott P. Crampton: Yes.

We thought and I think so and on a block of that thing.

If I could touch as briefly on this question of this securities exchange commission situation, it seems to us that any financial statements that might be submitted to the Security and Exchange Commission or for accounting purposes are usually designed to reflect a financial condition for a fixed period.

They do not usually look at external sources for supplemental information such as evaluations.

And the question here is whether the corporation is in a position to distribute these current earnings as dividends.

If the corporation contends that it has business needs then as we've mentioned we look at the available resources and this requires a measuring of assets during the period.

Their actual cost some years earlier is really we see -- we believe irrelevant to this economic examination of the period in time.

And I think the correctness of this position is demonstrated by the fact that you use value if it is less than cost in determining total resources as this Court has done in the National Grocery case.

If the cost were in fact the test you might find a situation where the tax payer had assets on its books considerably higher than their existing value at the time and they really didn't have them.

In summary, it seems to us that the statute requires a consideration of economic needs of the business if the corporation has net liquid assets substantial and excess of economic needs.

It should distribute its earnings or pay the tax.

It certainly should not be permitted to avoid the tax by simply investing funds in readily marketable security.

We believe that the decision of the Fifth Circuit was correct and should be affirmed.

Chief Justice Warren E. Burger: Thank you Mr. Crampton.

Mr. McAlpin, you have three minutes left.

Do you have anything further?

Argument of Kirk Mcalpin

Mr. Kirk Mcalpin: We won't take it Your Honor.

Chief Justice Warren E. Burger: You submit?

Mr. Kirk Mcalpin: Yes, sir.

We do.

Chief Justice Warren E. Burger: Thank you gentlemen.

The case is submitted.

Print this transcript Transcript:

Argument of Kirk M. Mcalpin

Chief Justice Warren E. Burger: We'll hear arguments next in 74-22, Ivan Allen Company against the United States.

Mr. McAlpin, you may proceed whenever you're ready.

Mr. Kirk M. Mcalpin: Mr.Chief Justice and may it please the Court.

The case before you today is in behalf for the taxpayer Ivan Allen Company.

This is a penalty tax case is that referred to you also is an accumulated earnings tax case had arises under Section 531, 537 Internal Revenue Code.

If the Court would permit, I might in one very brief moment spelled out the particular provision of 533 which is of issue in this case.

The very Section 533 portion which is particularly pertinent to the consideration says this, "The fact that the earnings and profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the income tax with respect to shareholders."

I might state briefly that Ivan Allen Company is involved in this case by reason of the purchase of Xerox stock in 19 -- for the years 1965-1966.

The issue here is whether or not Ivan Allen Company accumulated earnings beyond a reasonable needs of the business that we -- to their earnings and profits succeed are reasonable business needs for those years.

The issue has been framed by stipulation to present a relatively simple issue insofar as the business figures of the corporation are concerned.

The amount of Xerox stock, which we claim and did so claim successfully in the District Court, which was purchased from earnings, the accumulated earnings was $154,000.00.

That is the amount of investment which we have in liquid assets.

That amount was reflected in the year 1965 as $154,000.00 and the year 1966 a taxable year in June of 30th that was reflected as $135,000.00 because some of that Xerox stocks have been sold in the year 1965.

The question here before this Court and it's whether or not the earnings and profits in determining this question whether the earnings and profits exceed the reasonable business needs of the business are reasonable needs to be compared with the earnings and profits reflected in the liquid asset as we contend at cost or as the Government says, as total resources available including unrealized appreciation as the government contends.

The Xerox stock web from a basic cost of $154,000.00 in the year for the taxable year of 1965 to $1,640,000.00 rough years, and the year of 1966 as the records will show that same stock at that time $135,000.00 had a liquidation of market value less cost of your -- well, market value of that time of $2,500,000.00.

Justice William H. Rehnquist: Mr. McAlpin, why does an office supply company buy a stock like Xerox?

Mr. Kirk M. Mcalpin: Alright, sir.

The reason was, they were, I don't know if it's in the record, they were in the 3M, they had the franchise for 3M Machine, this old machine which Minnesota mined.

They lost that franchise, they saw that Xerox on the market.

They are aware and they saw that Mr. Allen back in the 60's.

He had some cash money, Your Honor, and this is accumulated earnings which a record will show was needed in operating capital stipulated that this cash, we agree as an operating capital.

He invested this in a security rather leave in oddly in the cash or just in the savings account.

Justice William H. Rehnquist: Do you say Mr. Allen had some money?

You --

Mr. Kirk M. Mcalpin: No, no, I'm saying he was part of the company as Mr. Ivan Allen I say --

Justice William H. Rehnquist: In corporation?

Mr. Kirk M. Mcalpin: It's a corporation.

He was the President of the company at this time.

But it was a corporation --

Justice William H. Rehnquist: It was a substitute for putting the money in the bank?

Mr. Kirk M. Mcalpin: Yes, sir.

As a matter of fact, this case would not be here today if Ivan Allen Company had just wanted to be safe and just leave the $154,000.00 in cash because it is stipulated by the Government that -- we so state that the cost to our investment as it is invested -- cost of our earnings that which is the investment of Xerox and liquid assets is available to meet reasonable business needs.

We say that the appreciation is not available that these are not earnings and that the amount earning so we paid tax of $154,000.00 which went into -- which are accumulated earnings had we left and I don't think the Government will contend otherwise, had we left that $154,000.00 just in cash have management which was hesitant to make decisions, hesitant to looked around and see what was a good investment for some temporary money while they are waiting to use as his operating capital, and this was and stipulated as to cost it was operating capital.

Have they left that $154,000.00 in cash as operating capital, there would be no claim because it is stipulated in this case that the amount of all reasonable business needs as an operated in capital $1,000,002.00 in 1965 and $1,000,004 in 1966 would equaled exactly the accumulated earnings for the years -- the same years of 1965 and 1966 if the stock is treated as we respectfully submit in earnings that the investment that they had in liquid assets that would be $1,000,002.00 which will be the accumulated earnings, and $1,000,004.00.

So you see, we are saying that $154,000.00 and respectfully $135,000.00 of those two years.

In cash, that was all the earnings we had.

We put it into the liquid assets, it was proper operate in capital and available to meet the business needs.

Now, here's the case and here's what the Government says --

Justice William O. Douglas: Mr.McAlpin, before you go on, you're talking about unrealized appreciation investment in stock market?

Mr. Kirk M. Mcalpin: That's correct.

Justice William O. Douglas: As of what dates are we talking about that the Government take year in market value?

Mr. Kirk M. Mcalpin: Yes, sir.

The government --

Justice William O. Douglas: This year in as I recall.

Mr. Kirk M. Mcalpin: Yes, sir.

June of 30th of 65' and June of 30th of 66'.

Now, the Government contends --

Justice William O. Douglas: Does the record show --

Mr. Kirk M. Mcalpin: Yes, sir.

I think --

Justice William O. Douglas: -- the high and low market --

Mr. Kirk M. Mcalpin: State by attorney at page 70 and page 90 --

Justice William O. Douglas: Mr.McAlpin, I'm asking you another question.

Mr. Kirk M. Mcalpin: Excuse me.

Justice William O. Douglas: Does the record show the high and low market price of Xerox in each of fiscal years in question?

Mr. Kirk M. Mcalpin: I'm not certain it does, it only shows the -- what the Government refers to as the net liquidation value.

They show the market and in the record shows the cost of conversion which will cost that showing does not show the variation.

Justice William O. Douglas: Is that taking into account the capital gain stocks?

Mr. Kirk M. Mcalpin: Yes, the cost of conversion --

Justice William O. Douglas: The cost of conversion is different from the --

Mr. Kirk M. Mcalpin: Oh, no that's the cost.

They have stipulated that there would be approximately -- I believe 37.5% if we did sell the stock.

That would be all our capital gain stock, the 6% other tax and then the -- some dispute about the Georgia tax but we claim that there is three taxes which would apply if we were forced to convert and therefore, we would not have the full value even under their theory available to meet business needs.

I think that is in the record Your Honor and stipulated.

Justice William O. Douglas: Mr.McAlpin, on page 55, I think there is a stipulation about the cost of converting and I suppose had the corporation on December 30th or two days before the end of the taxable year or maybe on fiscal year basis yes June 30th.

In June 28th if it had liquidated the Xerox stock without the net figure after capital gain and capital gain tax and brokerage commission, you wouldn't be here arguing then there would be an improper accumulation of surplus?

Mr. Kirk M. Mcalpin: Had we converted it?

Justice William O. Douglas: Had you converted it?

Mr. Kirk M. Mcalpin: Yes, sir.

But what we have done we would naturally we would have paid the capital of the intersection, Your Honor at that time.

We would then have as we did when we saw the thousand shares of Xerox in 1966, we would put it into our business for operation.

We would earn money.

We would pay for the income tax on that as we did in 1966.

You'll notice our earnings went up from $341,000.00 to $629,000.00 and we would have then -- yes, we would have used it and put it in but the question Your Honor may be this, does that statute 531 to 37 and the legislative history require a conversion of what the Government is claiming and what's he did successfully in the Fifth Circuit and prevailing upon the First Circuit to reverse Judge Moye with -- Judge Moye the District Judge established a principles which we urging in this Court.

What they would do then is force a conversion or if they certain the last day of our taxable year.

It would be without reference at all as to whether or not business judgment the term, and the time, and the place, and the best conditions under which investment should be sold and whether or not it would be wise to sell it all over at that time.

Justice Potter Stewart: What was the Government's theory, I thought it was -- first of all I don't think that the Government claims at all that this unrealized appreciation is itself earnings and profits.

But that the Government's theory is that with the existence of this large unrealized profit in the investments you made in this company that your other earnings and profits were more than available to meet the needs of the business and therefore, where you stand were declared, you're in trouble under the statute.

Mr. Kirk M. Mcalpin: But the Government says well, we --

Justice Potter Stewart: It doesn't say you should've sold your stock or had to sell your stock --

Mr. Kirk M. Mcalpin: So much I would asked would be necessary to pay the amount of the dividends or let's say claim we say we should pay all of our profit earnings and profits in the taxable years.

Now, Your Honor what they --

Justice Byron R. White: Often earnings and profits are not in cash.

That's true, isn't it?

Mr. Kirk M. Mcalpin: Oh, that's correct.

That's correct.

That would be reflected in property very frequently, yes sir.

Justice Byron R. White: Right.

Mr. Kirk M. Mcalpin: But the point is the statute makes a comparison.

We would submit that the statute makes a comparison as to earnings with the reasonable business needs for the taxable year.

Now, what they say is that they are not tax -- that's what they have taxing of that amount exceeds when you put market on it that that's what they're taxing.

But what they do, Your Honor, they go to liquid assets and they claim that all amounts which we are holding as investment in liquid assets under the Smoot case which we hold at cost, that is our cost a $154,000.00.

They take this and they put the appreciated value on it, and then they say, "You look at total sources of funds in making the comparison."

Now, there is no statute, no regulation under 535 or 531 in anyway that ever adopts except in this case and in the Fifth Circuit.

They did this and they call it in the tax court which we say is wrong.

We ask this Court to disregard that decision but what they do is that they take that figure which is in total -- which is in the liquid assets and they have interpreted that they say that all of your liquid assets, all the current liquid assets, that when you compare that with your business needs at a converted figure which would be the hundred to million sects that if that exceeds your reasonable business needs then you have accumulated earnings which you must pay tax on a county tax.

Now, --

Justice Byron R. White: Now, wait as minute.

Let's assume that the company buys some stock at for a $100,000.00 and it didn't enhances and that increases in value 10 times since it was a million.

Mr. Kirk M. Mcalpin: That's right.

Justice Byron R. White: And there it is and but the Government doesn't contend you have to pay any of that out any of that enhancement of?

Mr. Kirk M. Mcalpin: No, sir.

They say --

Justice Byron R. White: But if you -- if the next year you have a dollars worth of earnings and profits you had to pay that up.

Mr. Kirk M. Mcalpin: That's right.

They say we should --

Justice Byron R. White: But any year and which you have a loss you don't have to pay anything else.

Mr. Kirk M. Mcalpin: That's correct.

What they did --

Justice Byron R. White: So, it doesn't say that certain that the enhancements of earnings and profits suppose must be converted and paid out.

Mr. Kirk M. Mcalpin: They have met that that is not earnings but Your Honor the way they go about it is this.

They have applied a different rule.

They have -- they are forcing a conversion on your asset, your liquid -- the so much to your liquid assets are at cost.

Justice Byron R. White: They don't force the conversion.

They just say that your current year's liquid asset -- you current year's earnings and profits must be paid out.

Mr. Kirk M. Mcalpin: Well, but Your Honor the measure there the comparison is under Section 533 of the Code and the comparison the words are "earnings and profits" as you measure, you compare your earnings and profits for that year the accumulate earnings and profits -- your accumulate earnings and profits as against your reasonable business needs.

Now, if you look at cost, our reasonable business needs over $1,000,002.00 in 65' are accumulated earnings of $1,000,002.00.

They agree then that's exactly the same.

Now, what they're saying that you take total resources, you take your liquid assets and when you take liquid asset you appreciate the stock which has a cost value reflected in liquid assets.

Now, we'll come to that word, that is a very critical word because if misstated the rule we submit in the Smoot case.

Justice William O. Douglas: Which is a critical word?

Mr. Kirk M. Mcalpin: The word "reflected" the Smoot case in 1960 --

Justice William O. Douglas: Incidentally, it is agreed that the Xerox stock is completely marketable it is liquid, I take it here.

Mr. Kirk M. Mcalpin: Yes, sir.

But this case would be establish in the rule though, in this particular instances it is liquid.

We would loss value in the courts we have come at par.

We would loss value of approximately from 30% to 37% or maybe by reason of conversion.

We will be forced to sell it is liquid but this would apply to closely held corporations in which one of the concerns would be evaluation, it would a closely held corporations stock be able to have an available ready sale.

Now, you see the Ninth Circuit in Golconda, they held that eventhough there's tax Court, they held it was an applicable because it was a publicly held corporation.

So, the imposition that would be establish in this case under Fifth Circuit has established says that," at the end of every taxable year that all your total, not your earnings and profits as the statute says, all your total resources must be look to, to see whether or not you can meet your reasonable business needs."

Now, that means on December the 31st you have effect that they have been told that that market value whatever the stock is at that time stock market value at that time establishes that you have been told, you have that you will be in place of market value on it.

Now, let's assume Your Honor and we say and you set it in this Court in Eisner in 1938, you have very -- you expressed concern about force conversion, the American Trading Company Fourth Circuit did the same thing in 1973.

What you would do in December the 31st, you force -- you make him determine a market value on that stock.

The question is and this is where the error is, there is no insurance that that will continued to be available into the next year even under January of 2nd, suppose in antitrust suits or some fraud suits were filed.

You say that where stock is worth a billion and a half dollars or in antitrust suit was filed against Xerox Corporation on January 1st.

You have established that not by business judgment but by the determination of the Government.

The Government has come in and told you when your sale is and on January the 2nd, the question is continue the availability to meet prior operating in business needs.

Now, on January the 2nd, something completely happens as to Judge Moye says secretary of State's petitions it goes to Europe.

Justice William H. Rehnquist: Well, even if that doesn't happen, isn't one of your responses to Justice White's earlier question that even though you're not told by the government to liquidate your Xerox stock, if you have to distribute all of your earnings and profit to make up operating needs.

You're going to have to liquidate some of your Xerox stock.

Mr. Kirk M. Mcalpin: Yes, sir.

But only, Your Honor, only to the extent of a hundred -- yes, operating needs $154,000.00.

Now, we stipulate as part of our operating capital.

We would have to sell $154,000.00 worth to take care of it but we would have to sell all of it.

Now, what the Government -- we would have to sell the whole thing we just have to sell that $154,000.00 of our amount.

What or maybe, it maybe more but what the Government is saying is when you measure it we had to -- they have said we have to pay out the whole $600,000.00 of profits for the taxable years that we had dividend then we should pay all of that out.

Now, we did pay out a dividend and we have been paying our dividends but they said all of it should be because when you take your appreciated value, they say they're not tax, and they have met they say appreciation is not an income.

But what they have done is they have converted earnings in some form or another to look equity, they used another equity test and which they say that you reach up in any total resources.

Now the question I want to make, the Smoot test, they say Smoot.

Smoot was a case in which was referred to is a pre-Smoot days and post-Smoot days, before, it was the size of the accumulated earnings; they look the accumulated earnings to determine whether or not you had accumulated in excess your reasonable the business needs.

In 1960, in the Smoot case, what they have did they separated, they said there are certain things while they are earnings.

There is no way you can use those for to me reasonable to business needs.

They are in your plant in your equipment.

So, they took that out.

They said, "To the extent your earnings to that you can accumulate with impunity."

Then they came and said, "Now, what we should do for a practicality of this?"

And this as they establish a liquid assets and said that so much of surplus as it is reflected in the liquid assets so much of the earnings -- earnings separate -- you separate the same thing.

So much as it is reflected in liquid assets are to be measured against the reasonable needs and if you exceed that then you have violated the statute.

Justice Byron R. White: But wouldn't you be here making the same argument if for some reason or another the company had liquidated its Xerox stock and were sitting there at the end of the year with the money in the bank having paid its capital against tax.

Wouldn't you say that --

Mr. Kirk M. Mcalpin: No, we would pay to dividends Your Honor.

That what -- if we have liquid --

Justice Byron R. White: No, wouldn't you be still be making the argument that insofar as the cash that you now had, absolute cash, reflected in enhancement -- in stock value that you wouldn't -- that it could not be and should not be considered in --

Mr. Kirk M. Mcalpin: No, sir.

No, sir.

We have agreed that the stock of our earnings are invested --

Justice Byron R. White: Well, it isn't my point.

I know you've agreed that that to your stock costs --

Mr. Kirk M. Mcalpin: Is $154,000.00.

Justice Byron R. White: Yes, but --

Mr. Kirk M. Mcalpin: It's probably reasonable business needs.

Justice Byron R. White: Yes, but now let's assume that the stock had gone up to a million dollars and you sold it.

Mr. Kirk M. Mcalpin: We did do that in 1966.

Justice Byron R. White: Alright and let's assume you sold it you had the cash in the bank.

Now, is that available to measure --

Mr. Kirk M. Mcalpin: That would be part of our liquid assets and to meet reasonable business needs.

Justice Byron R. White: And the Government then could take that into account?

Mr. Kirk M. Mcalpin: That would go into our earnings.

We did do just sell.

We sold a thousand shares and then put it in --

Justice Byron R. White: It was going to your earnings -- it would be part of your earnings because it was gain, I mean, it was earnings, it was income because you sold the stock?

Mr. Kirk M. Mcalpin: That's correct.

No question about it but we elected and did to the converting.

It was a business judgment as to when it was desirable.

Justice Byron R. White: Alright, but now let's assume that you paid the tax on it that year and you took it in the income that year.

Mr. Kirk M. Mcalpin: Alright, sir.

Justice Byron R. White: Next year, you still got the money in the bank and then you have some more earnings and profits, must you pay the amount?

Mr. Kirk M. Mcalpin: Absolutely, that would then be income and we would be --

Justice Byron R. White: So, you not still accumulated earnings and profits in it?

Mr. Kirk M. Mcalpin: But then, we would make the pay the dividends is the question here Your Honor is, when is it wise to do that?

I know we're not trying to mean anyway technical.

Justice Byron R. White: So, you're -- and this is unrealized income?

Mr. Kirk M. Mcalpin: Unrealized income as unrealized appreciation.

Justice William O. Douglas: And this has to be your answer what you just gave to Mr. Justice White has to be your answer really and what your opinion your case on is that it is unrealized and liquidated --

Mr. Kirk M. Mcalpin: That's correct.

Justice William O. Douglas: -- and you want the privilege of a business judgment and as to one --

Mr. Kirk M. Mcalpin: That's correct, Your Honor and while it maybe that we are following we say has good reason.

They stat -- the legislative history of this particular Act since 1954 has been to favor of taxpayer, the language of words earnings were deliberate.

They are to determine the source and which the funds to be pay the legislative history shows that every amendment has been favor in the small businessmen, just this year the exemption is going from $60,000.00 to 1975 or $175,000.00.

The question of reasonable business needs, you used to have to have a specific plan.

It was amended at Section 537 to say reasonably forcible needs and here, we come right that now to include these new ideas which the Government is injecting and there is no word of liquidity, there is no -- the statute then used liquidity test.

The liquid assets test which they have misconstrued in this brief, we're saying to the Fifth Circuit.

Likewise, puts your evaluation on a basis of measuring of earnings and while the legislature has -- the Congress has written in this way in Bronstein case in 1963.

You recognized that while it was a matter of taxation and that that's the way the legislation was written and it was a matter -- if that's the way Congress did it and it didn't appear to be a type of situation for the judicial determination.

We would submit, Your Honor that the question of a legislative interpretation is very deliberate here, it's very much designed because they even recognize that they were concern about the Government harassing, it's in our brief, harassing small businessmen and they have now took the penalty tax off, and another thing we must recognize that this is a penalty judge.

We pay the income tax and the rule of Goal versus Golez, in the case of penalty taxes that you must construe any enlargement of misconstruction or interpretation question as against the Government and for the taxpayer.

We say there is no ambiguity.

The term in 1936 the word "gain" was change to "earnings", so, of the earnings and profit and every measure, every deliberate concern of the legis -- of Congress has been on earnings and yet, they bring --

Justice Byron R. White: I don't understand the government to be contending of course we'll hear from them and due course, but I don't understand then to be contending that this unrealized appreciation is earnings and profits.

Mr. Kirk M. Mcalpin: They contend that it is not, Your Honor.

But what they --

Justice Byron R. White: You concede that it is not.

Mr. Kirk M. Mcalpin: They reach out for a new term called "total resources available."

Justice Byron R. White: Yes.

Mr. Kirk M. Mcalpin: That's not what the statute says, the statute says, "earnings and profits available."

Justice Byron R. White: Well, did have earnings and profits --

Mr. Kirk M. Mcalpin: Yes, sir.

Justice Byron R. White: -- and the Government's position is where this unrealized appreciation of the Xerox stock, those earnings and profits were unreasonably accumulated if they weren't paid out.

Mr. Kirk M. Mcalpin: But they --

Justice Byron R. White: Now also, I should point out that the dividends doesn't have to be a cash dividend.

The dividend could've been paid out in the form of Xerox of stock --

Mr. Kirk M. Mcalpin: Well, Your Honor --

Justice Byron R. White: -- to your shareholders.

Mr. Kirk M. Mcalpin: That's very interest and I'm glad you mentioned it because one of the indications that cause a proper value is in regulations to 562 when you give your unrelated stock out they give you a credit only at cost.

They don't give bucket.

Yes, what they trying to do is trigger us at market example in when we give -- when we transfer 870 shares of Xerox to our shareholders in 1965, it had a market value approximately $87,000.00.

If you notice on your balance sheet that in that year, we were going to credit for $6,500.00, Section 312 of the Internal Revenue Code talked about earnings says that there must be that when there's a recognition at the time that that is when the gain and that's when earnings become indicative.

It is nothing in the statute --

Justice Potter Stewart: And it's the shareholders' basis on receipt of dividend in kind as the basis for each share, the corporation's cost --

Mr. Kirk M. Mcalpin: He has to pay, when the shareholder gets it, they give the corporation only cost deduction but when he gets it he must pay market value.He pays tax on a basis of market value.

Justice Potter Stewart: That's dividend, the market value and what's the -- and then his basis if he later sells at this market --

Mr. Kirk M. Mcalpin: It is a new market.

Justice Potter Stewart: Yes.

Mr. Kirk M. Mcalpin: And as American Trading you asked by the dividend American Trading -- the Government made the same contention there.

They said what that would do is dissipate the entire thing that they would have -- first, you loss 37.5%.

The Government determines when you sell your stock and on that very day, you loss up to 37.5% in your value which is not available to meet, then you get a cost deduction and if it's treating you at market and then your stockholder has to pay the full value when he gets it.

Now, as the Court said in the Couch Nebraska 1964, I hate to say that to the Court but it's on point and I think it's very significant.

They say, "They hope that they don't see day the courts said."

When government invades business to such of extent, in this very issue, that they can determine when stocks are sold and therefore, they held in that case that force conversion was not desirable that whether was doing is put in Government in the back -- into the management seat and all decisions are manageable will be trigger thereafter.

We submit as you have also said in Eisner that this was not the effect design and other issues I know I could treat but --

Chief Justice Warren E. Burger: Very well, Mr. McAlpin.

Mr. Crampton.

Argument of Scott P. Crampton

Mr. Scott P. Crampton: Mr.Chief Justice and may it please the Court.

I'd like to start at the outset and try to put in focus our understanding of these statutes that we have before you.

The basic purpose of course is to avoid the so-called "incorporated pocket book."

Congress determined that stockholder should not be permitted to accumulate idle funds in a corporation in order to avoid dividend taxes that they would otherwise have to pay themselves.

As we look at the statute, there is a two fold test here.

The first, Section 531 imposes the tax on the accumulated taxable income.

This is an additional tax on income for a given taxable year.

It applies only to that income which is permitted to accumulate in that particular year.

The income involved is determined basically from the books of the corporation and it is determined in much the same way as your regular corporate income is determined but then modified for certain adjustments.

And so far as we see it, this is simple book keeping, you come up with income that's determined the way everyone understands it.

If you have no income, you have no problem under this statute.

If income does exist though, when you've done this computing and it is not distributed as dividends to the stockholders, then you look to see if this income can be distributed without a hardship to the company.

The statute speaks of the earnings and profits being permitted to accumulate beyond the reasonable needs of the business.

And I think the word "needs" here is the keyword for our second test.

It seems to us that this isn't economic test.

Here, the statute departs from concepts of taxable income that we know under bookkeeping and it requires us to measure the resources of the corporation against its needs.

The case is construing the statute refer to this as "net liquid assets."

If you take your current assets and your current liabilities and you see what are the economic resources that the corporation.

Justice William O. Douglas: Mr.Crampton.

Mr. Scott P. Crampton: Yes, sir.

Justice William O. Douglas: What do you mean by liquid assets?

How did you define them for this purpose?

Mr. Scott P. Crampton: I think those are read assets that can be readily converted to cash, probably inventory receivables things like that that would come into income within a year or less than a year.

Justice William O. Douglas: Suppose you had a highly marketable piece of real estate that you can sell any day.

Mr. Scott P. Crampton: I think that would probably a liquid asset then assume in your premise.

Justice William O. Douglas: Right, how would you determine the value?

Mr. Scott P. Crampton: I think you have to determine the value of these properties as the same way we determine values in many other areas like you would for estate tax purposes in the question of condemnation.

You have a question here it's a fact question, that the Court would have to consider.

Justice William O. Douglas: And that means that the Government would get an appraiser and the taxpayer would get an appraiser and they would be miles apart and they compromise somewhere in the middle which is what is usually happens.

Mr. Scott P. Crampton: Well, I think Your Honor in the situation you gave or you said it was readily saleable, I doubt if you'd have much of evaluation problem there, if there somebody wanting to buy this property you probably have pretty good idea what the sales price would be.

Justice William O. Douglas: You have to sell it they would find it?

Mr. Scott P. Crampton: That's true.

But that's true of your -- of any security like the Xerox stock here it have to be sold or some fluctuation in the market from the day to day.

But we don't think you need to get into that much of a refinement.

You look to see whether or not there is current assets here sufficient that the corporation could pay out these earnings and profits without disturbing its normal needs.

Justice William O. Douglas: Do you recall what the fluctuation in Xerox stock was in the year 1974?

Mr. Scott P. Crampton: No sir,I don't know.

I've got it here but I know it's a volatile stock in 74' --

Justice William O. Douglas: It arranged according to mode year from 55 to and 134.

Now, which day would the Government pick?

Mr. Scott P. Crampton: I don't think you pick a day on this as we view the case.

Your Honor, you would look at the situation over the year and if there's a minimum value of 55 certainly that would be I think a realistic value to take.

If that is the law because we are -- we're not trying to force a conversion here.

We're just saying it you know in a day to day market place you've got some assets here and if you're sure that you can realize at least $55.00 of share on it, then that's something we could look at.

Justice William O. Douglas: So, if there was a lower market value in the fiscal year in question the taxpayer could've taken that for purposes of this case.

Mr. Scott P. Crampton: I would think that would be reasonable.

Justice William O. Douglas: I thought the -- I thought you took the market value on the last day of the taxpayer's of fiscal year.

Mr. Scott P. Crampton: I don't think it's ever been refined to that point.

Justice Byron R. White: No, I thought that was your point in this case?

Mr. Scott P. Crampton: No, we have stipulated what the values were with counsel.

We were trying to get out of the case some of these detail factual things and we have agreed with counsel for the taxpayer that these were the values and we have reduced those values by the capital gains tax and by the brokerage made of points, so as far as this case is concern, we have hard figures that these are the fair market values that both parties agreed they could use and then we have the cost figures which were equally refer.

Justice William O. Douglas: Mr.Crampton, before you go on, how would sound the accounting principles require a corporation to carry the value of this Xerox stock at any particular day?

Mr. Scott P. Crampton: Oh, I think cost clearly.

Justice William O. Douglas: There's no question about that, is there?

Mr. Scott P. Crampton: Not in my mind but I do know that most accountants will also and this taxpayer did.

They showed the market value.

I think at the end of the year as not quite a footnote but parenthetical addition to their balance sheet.

Justice William O. Douglas: And if you file the registration statement with the SEC and undertook to show your assets at market you get deficiency immediately, wouldn't you?

Mr. Scott P. Crampton: You certainly -- they wanted to explain very carefully how you determine that this was the value you were putting on it.

Justice William O. Douglas: And the reason for that is that there's nothing definite, really definite except cost.

Mr. Scott P. Crampton: That's true.

Justice William O. Douglas: Market value varies -- it can't vary in with respect to stocks from day to day very widely.

Mr. Scott P. Crampton: I agree.

Chief Justice Warren E. Burger: Mr.Crampton, what if this taxpayer had purchased Xerox that the highest points, whatever that was, and that you were dealing with it in terms of today's market value, so that there would be an enormous unrealized loss.

How would that figure in the process of taking in to consideration and language of the regulation taking into consideration of the total picture?

Mr. Scott P. Crampton: It's our view that the rule works both ways if you bought at the higher figures, Your Honor suggest and now it is not worth that then it's the existing market value that you look at in determining the needs of the business, and that was the holding of this Court in the National Grocery case which we referred in our briefs, in that case, they had earnings I think of some $800,000.00 and then admitted security losses of $2 million and the Court said, "You do look at the present value of those securities."

And there's a quotation in our brief it's quite clear and I will come into it in a minute but the Court then went and had impose the tax because as you look over a 10-year average the had accumulated earnings and profits or something like $5 million that had never paid a dividend.

But the Court there announced the rule and we think this is just the opposite of it and we certainly say the rule works both ways.

Now, I think the pivotal question here, is how the resources of business should be measured?

The counsel for taxpayer has set forth some of the facts but I'd like to summarize them briefly against the statute as we've indicated the facts that have been stipulated.

This corporation had earnings after federal income taxes of about $180,000.00 in 1965 and almost $400,000.00 in 1966.

It paid less than a third of these amounts out in dividends.

In 1965, it paid $49,000.00 in cash dividend and distributed 870 shares of Xerox stock, in 1966, paid out $50,000.00 in cash dividends and a 10% stock dividend.

Its reasonable needs as I say have been stipulated for 1965 they need at almost $2 million, I mean, a $1,200,000.00 and in 1966, they needed practically a million and a half, and these are liquid assets taken at book value and the parties has agreed that these amounts equal in needs of the business.

If -- these are the liquid assets and they are the needs if you look at the book figures.

Now --

Justice Potter Stewart: What are liquid assets taken at book value?

What are you talking about now, the earnings and profits of that year?

Mr. Scott P. Crampton: No.

These are the assets on the books I have indicated, I think they would be realized within a year and the payables within a year.

It's the readily receivable things that can be converted into cash if you need to, and that brings us right to the point of how you value the Xerox stock.

We have --

Justice Potter Stewart: As you can see that -- have there been no appreciation in value of the Xerox stock? There could've been no violation of the statute --

Mr. Scott P. Crampton: Under these facts, there been no liability at all.

We agree with that and I think that the stipulations were designed to point that up and the real question is, we have also stipulated that after allowance for the capital gain's tax and the brokerage fees that the liquid assets of this corporation are practically double the figures that we stipulated as the corporate needs.

The liquid assets, if you look at fair market value or $2 million and two some in 1965 over $3 million in 1966, and here, 76% of the voting stock was owned by Ivan Allen Sr. and Ivan Allen Jr. and because of that, the commissioner of Internal Revenue determine this assessment.

Chief Justice Warren E. Burger: I think we'll resume there Mr. Crampton.