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October 23, 1973


C.A. 3d Cir.

[ 414 U.S. Page 982]

Certiorari denied.


The five petitioners in this case own virtually all the outstanding stock of a small corporation, A & S Transportation Co. (A & S). The company operates a barge. The barge fell into such disrepair as to require replacement, but A & S lacked the necessary resources and credit. A & S requested the Federal Maritime Commission to guarantee, as it is empowered by law to do,

[ 414 U.S. Page 983]

     a proposed first mortgage loan from a bank. Before the Commission would extend its guarantee, it required of A & S at least $150,000 of additional private capital. The Commission presented A & S with two options. A & S could resort either to subordinated debt or to the issuance of nonvoting, nondividend paying, non-cumulative preferred stock unredeemable until full payment of the desired loan.

 A & S chose the latter course. In proportion to their holdings of A & S common, petitioners in 1959 purchased $150,000 of preferred stock possessing all the attributes required by the Commission. The loan was then consummated with the Commission's guarantee, and A & S purchased a replacement vessel. By 1964 the loan was paid off in full. Having no further need for the $150,000, and in accord with the wishes of petitioners,*fn1 A & S redeemed the preferred stock in 1965 and 1966 in two equal installments. No premium was paid, and petitioners received precisely the amount each had previously invested. The Commission of Internal Revenue treated the redemptions as the receipt of ordinary income, taking the view that they were "essentially equivalent to a dividend" within the meaning of § 302(b) (1) of the Internal Revenue Code of 1954, 26 U.S.C. § 302(b) (1). Citing United States v. Davis, 397 U.S. 301 (1970), the Tax Court agreed. Miele v. Commissioner, 56 T. C. Memo 1971-161. The Court of Appeals for the Third Circuit affirmed without published opinions. Miele v. Commissioner, 474 F.2d 1338 (1973); La Fera Contrating Co. v. Commissioner, 475 F.2d 1395 (1973); Spiniello v. Commissioner, 475 F.2d 1396.

On the above facts it seems plain that the redemption of preferred stock provided petitioners nothing more than a return of the capital they were compelled by the Commission to pay into A & S to obtain the additional financing the corporation needed to remain in business. To tax that return of capital at ordinary income rates is an extraordinary result, yet one that I recognize to be mandated by the full sweep of United States v. Davis, supra. Because of strong doubts as to the correctness of any decision that produces such a bizarre result, I would grant certiorari to reconsider Davis.*fn2

Section 302(b) (1) of the Code shelters from dividend treatment, and accompanying potential ordinary income consequences, any stock redemption that "is not essentially equivalent to a dividend."*fn3 A majority of the Court in Davis read that provision to mean that a stock redemption by a small, closely held corporation

[ 414 U.S. Page 985]

     is "always "essentially equivalent to a dividend" " where there is no "change in the relative economic interests or rights of the stockholders." 397 U.S., at 307, 313 (emphasis added). Undoubtedly the Court sought to promote ease of administration through adoption of a simplistic, per se rule. Yet the Court explicitly recognized that the weight of authority in the lower federal courts was contrary to its mechanical approach. Id., at 303 n. 2. Furthermore, the Court conceded that the "legislative history is certainly not free from doubt." Id., at 311.

In my view, the result produced by Davis in this case is justified neither by the language of the Code nor by the legislative history, and certainly not by precedent prior to Davis. In these circumstances, ease of administration is too high a price to pay for the presumably unforeseen and undeniably harsh consequences visited on these and similarly situated taxpayers.

The Tax Court noted petitioners' position "that the preferred stock was no longer needed after the loan had been paid in full and that redemption of the stock was consistent with the business purpose for which the stock was issued." Miele v. Commissioner, supra, at 567. The Tax Court did not refute the factual correctness of this position, or consider whether there had been a tax evasion motivation.*fn4 Rather, that court simply disregarded all factual considerations as immaterial to an application of the Davis per se rule:

"We consider [petitioner's] argument as having been foreclosed and the issue determined by the case of United States ...

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