Petition for Writ of Certiorari — Norman E. Albers, Executors, Estate of Joseph Miele v. Commissioner of Internal Revenue

ESTATE OF JOSEPH MIELE, Deceased,

Normaw ©. Auzers, Nicwoias Joya and Horace D. Marvo-

ct, Executors, ANTHONY P. MIELE and MARIA E.

MIELE, V. JAMES SPINIELLO and GLORIA SPIN-

IELLO, LUK# C. SPINIELLO and GRACE SPIN-

TELLO, and LaFERA CONTRACTING COMPANY,

Petitioners,

v8.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

— >>) EEE —————————ESee

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

THE THIRD CIRCUIT

i ____

Marts D. Conzn,

Attorney for Petitioners,

744 Broad Street,

Newark, New Jersey 07702.

INDEX TO PETITION

PAGE

Pretrurmary STATEMENT

Orrmtons BeLow

JURISDICTION

Questions PResENTED

Statutes anp Recuiations Lyvoivep

SraTEMENT OF THE CasE

Reasons For Grantioxe THE Wait:

1. United States v. Davis, 397 U. S. 301 (1970),

regarded by the courts below to be controlling

herein, should be reconsidered 6

2. This case presents an important policy ques-

tion, not raised or considered in United

States v. Davis, supra, affecting the just ad-

ministration of the revenue laws

wo oo ht t =

v=)

Conclusion 12

APPENDIX:

A—Official Findings of Fact and Opinion of the

United States Tax Court la

B—T. C. Memo. 1971-161 | 16a

C—Judgment Order . 18a

D—Order of the United States Tax Court ..... 22a

Cases Cited

Boys Markets, Inc. v. Retail Clerks Union, 398

U. S. 2385 (1970): 9

an

ii TABLE OF CONTENTS

PAGE

Davis v. United States, 408 F. 2d 1189 (6th Cir.

1969), 7,8, 11

Earle v. Woodlaw, 245 F. 2d 119 (9th Cir. 1957)... 7

Flanagan v. Helvering, 116 F. 2d 937 (D. C. Cir.

1940)

Helvering v. Hallock, 309 U.S. 106 (1940)

Heman v. Comm’r, 283 F. 2d 227 (8th Cir. 1960)...

’ Jones v. Griffin, 216 F. 2d 885 (10th Cir. 1954)...

Keefe v. Cote, 21S bag 651 (1st Cir. 1964)...

Mastro Plastics Corp. v. NLRB, 350 U. S. 270 (1956)

Smith v. United States, 130 F. Supp. 586 (Ct. CL

1955) ve 7

Thomas Kerr, 38 T. C. 723 (1962), aff’d 326 F. 2d

225 (9th Cir. 1964) 7

United States v. Davis, 397 U. S. 301 (1970)......3, 5-7, 9, 11

United States v. Fewell, 255 F. 2d 496 (5th Cir.

i i |

1958) 7

Statutes Cited

Internal Revenue Code of 1954:

See. 302 3

See. 302(a) 6

See. 302(b)(1) 3,68

Merchant Marine Act of 1936, as amended:

Subchapter XI 3, 10, 11

28 USL.:

Sec. 1254(1) 2

TABLE OF CONTENTS iii

PAGE

46 US.C.:

See. 1271 3,10

Sec. 1278 10

Rule Cited

Rule 23 (Par. 1), 1

Other Authorities Cited

Bacon, “Share Redemptions”, 26 Tax. L. RB. (1971):

283, 289 ‘ : 8

Roberts, et al., “Complexity and Income Tax”, 27_

Tax L. R. (1972):

325, 358-359 7

Regulations Cited

Treasury Regulations:

See. 1.302-2 3,8

Sec. 298.4(n), published in the Federal Register

(23 F. R. 384), January 22, 1958, as General

Order 29, Revised 3, 9,11

7 a A ae

.

ESTATE OF JOSEPH MIELE, Deceased,

Norman E. Ausers, NicHotas Joya and Horace D, Manvo-

ct, Exeeutors, ANTHONY P. MIELE and MARIA E.

MIELE, V. JAMES SPINIELLO and GLORIA SPIN-

ITELLO, LUKE C. SPINIELLO and GRACE SPIN-

TELLO, and LaFERA CONTRACTING COMPANY,

Petitioners,

‘ v8.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

Petitioners pray that a writ of certiorari issue to re-

view the respective judgments of the United tates Court

of Appeals for the Third Circuit, rendered below (Nos.

72-1031, 72-1032, 72-1254, 72-1255 and 72-1368).

Preliminary Statement

This is a single petition filed under the authority of

Rule 23 (Paragraph 1.) to seek review of five related

cases involving identical facts and questions of law.

sn sen monn wr ten eepeeng ments ety ap oe —_————

2 .

One of the parties below, Joseph Miele, died following

remand of his case to the Tax Court by the Court of Ap-

peals. By order of the Tax Court dated May 8, 1973

(Appendix D, p. 22a), the Estate of Joseph Miele has

been substituted as a party.

Opinions Below

The findings of fact and opinion filed by the Tax Court

- in the Miele and Spiniello cases are reported at 56 T.C.

556 (Appendix A, pp. la-l5a).

- The memorandum findings of fact and opinion of the

Tax Court in the La Fera case, not officially reported, has

been designated “T.C. Memo. 1971-161” (Appendix B,

infra, pp. 16a-17a).

No opinion was filed in the Court of Appeals, which,

however, issued Judgment Orders in all five related cases

(Appendix C, infra, pp. 18a-21a), affirming the respective

decisions of the Tax Court in respondent’s favor.

Jurisdiction

The judgment of the Court of Appeals (in Nos. 72-1031

and 72-1032 below) was entered on January 30, 1973.

Appendix C, infra, pp. 18a-19a). With respect to such

judgment, the time for filing a petition for a writ of cer-

tiorari was extended, by order (dated April 17, 1973) of

Mr. Justice Brennan, to and including June 29, 1973.

The judgment of the Court of Appeals in (Nos. 72-1254,

72-1255 and 72-1368, below) was entered on April 11,

1973. (Appendix C, infra, pp. 20a-21a).

The jurisdiction of this Court is invoked under 28 U.S.C.

Section 1254(1).

3

Questions Presented

1. Whether United States v. Davis, 397 U.S. 301 (1970)

is correct in holding that the business purpose of a trans-

action is irrelevant in determining dividend equivalence

under section 302(b)(1) of the Internal Revenue Code?

2. Assuming, arguendo, that United States v. Davis,

supra, enunciates a correct general rule, does not simple

justice preclude application of so rigid a rule to a trans-

action whose form is virtually dictated by regulations of

a Federal agency?

Statutes and Regulations Involved

The pertinent provisions of section 302 of the Internal

Revenue Code of 1954; of §1.302-2 of the Treasury Reg-

ulations promulgated thereunder; of Subchapter XI of the

Merchant Marine Act of 1936, as amended, 46 U.S.C.

§1271 et seq.; and of Regulations §298.4(n) promulgated

thereunder, are set forth under “Reasons for granting the

Writ”, infra.

Statement of the Case

As noted under the heading, “Opinions Below”, supra,

no opinion in these related cases was rendered in the

Court of Appeals, which by “Judgment Orders” affirmed

the Tax Court’s decisions in favor of the government.

For purposes of this petition the briefest outline of the

facts, as found by the Tax Court, is sufficient.

A & S Transportation Co. (hereinafter referred to as

“A & S”) was incorporated under the laws of New Jersey

on January 17, 1945. Its original authorized capital con-

sisted of 1,000 shares of common stock having a par value

of $100 per share (App. A, pp. 2a-3a).

4

With insignificant variations, the beneficial interests in

132 issued and outstanding shares of A & S common stock

(as described above) have been held at all material times

as follows (App. A, p. 3a):

Beneficial Owner Number of Shares

Joseph Miele 22

Anthony P. Miele 22

Luke Spiniello 22

V. James Spiniello 22

La Fera Contracting Co. 44

At all times since its incorporation, A & S has been

engaged in the business of moving sludge out to sea by

means of one or more sea-going barges (App. A, p. 4a).

For more than a decade following its incorporation in

1945, A & S conducted its business by operating a single

barge, the “Dykes”. By 1956, exorbitant repair costs

made replacement of the “Dykes” a business necessity.

Resort was had to the Maritime Commission, empowered

(under the Merchant Marine Act of 1936) to encourage

the development of a domestic merchant fleet by insuring

marine construction loans (App. A, p. 4a).

Pursuant to the requirements of the Maritime Admin-

istration, dealing with Federal Ship Mortgage and Loan

Insurance, A & S was required to have a prescribed mini-

mem equity capital in order to be eligible for the neces-

sary amount of loan and mortgage insurance (App. A,

p. 5a).

In 1959, the stockholders of A & S complied with such

requirement by making $150,000 of their personal funds

available to A & S. Such capital contributions were made

by the taxpayers in direct proportion to their respective

5

holdings of A & S common stock. In exchange they re-

ceived certificates denominated, “non-voting, non-dividend

paying, non-cumulative preferred stock”, which could be

redeemed, at par, after five years; and had to be re

deemed at par no later than ten years after issuance

(App. A, pp. 5a-Ga).

A & § obtained an insured ship mortgage loan in the

amount of $380,000. acquired a new barge with the pro-

ceeds, and operated it successfully thereafter (App. A,

p. 7a).

By August 31, 1964, the ship mortgage loan had been

paid off in full. Having no further need for the $150,000

paid in by its stockholders, A & S returned their money

to them, dollar for dollar, during 1965 and 1966; and the

so-called preferred stock was “redeemed” (App. A, pp.

7a-8a).

The Tax Court rejected the taxpayers’ alternative con-

tentions (1) that the A & S preferred stock issued in

1959 and redeemed in 1964 and 1965 was in reality debt;

and (2) that the rigid rule of United States v. Davis, 397

U. S. 301 (1970) ought to be avoided herein in view of

both factual distinctions and equitable considerations

(App. A, pp. 14a and 15a).

The Court of Appeals affirmed on authority of United

States v. Davis, supra (App. C, p. 19a). -

REASONS FOR GRANTING THE WRIT

1. United States v. Davis, 397 U. S. 301 (1970),

regarded by the courts below to be controlling here-

in, should be reconsidered.

(a) Davis involves section 302(b)(1) of the Internal

Revenue Code of 1954,’ which, in conjunction with section

302(a),? permits a redemption of corporate stock which

“is not essentially equivalent to a dividend” to be treated

as a return of capital.

Davis, adopting a so-called “strict net effect test”, holds

that section 302(b)(1) must be applied to redemptions on

a strictly objective basis without regard to the business

purpose, if any, for the transaction and solely be refer-

ence to whether the exchange causes “a meaningful reduc-

tion of the shareholder’s proportionate interest in the

corporation”.

Prior to Davis, and contrary to its holding, the Tax

Court, the Court of Claims, and most Courts of Appeals

1 Internal Revenue Code of 1954 (26 U.S.C.).

Sec. 302. Distributions in Redemption of Stock.

(a) General Rule—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 re-

demption shall be treated as a distribution in part or full

payment in exchange for the stock.

(b) Redemptions Treated as Exchanges.—

(1) Redemptions not equivalent to dividends.—Subsec-

Se ee OO ee © Se ey

equivalent to a dividend.

2See fn. 1, supra.

effect test”. Thomas Kerr, 38 T. C. 723 (1962), aff’d 326

F, 2d 225 (9th Cir. 1964); Smith v. United States, 130

F. Supp. 586 (Ct. Cl. 1955); Flanagan v. Helvering, 116

F. 2d 937 (D. C. Cir. 1940); Keefe v. Cote, 213 F. 2d 651

(1st Cir. 1954); United States v. Fewell, 255 F. 2d 496

(5th Cir. 1958); Davis v. United States, 408 F. 2d

(6th Cir. 1969); Heman v. Comm’r, 283 F. 2d 227 (

Cir. 1960); Earle v. Woodlaw, 245 F. 2d 119 (9th Cir.

1957) ; Jones v. Griffin, 216 F. 2d 885 (10th Cir. 1954).

The “flexible net effect test”, in general, results in a

finding of non-dividend equivalence under section 302 (b)

(1), where the redemption is untainted by any tax avoid-

ance motives and has its roots in legitimate business pur-

poses.

(b) Only six members of this Court, as now constituted,

participated in United States v. Davis, supra. Mr. Justice

Marshall wrote the majority opinion with Mr. Justice

Stewart and Mr. Justice White joining; whereas Mr. Jus-

tice Douglas wrote a dissent with which the Chief Justice

and Mr. Justice Brennan concurred. Id. 313.

(c) The majority opinion acknowledges that “the in-

tended scope of §302(b)(1) as revealed by [its] this legis-

lative history is certainly not free from doubt”. Id. 311.

(d) Davis has been criticized as representing unwar-

ranted judicial legislation. Roberts et al., “Complexity

and Income Tax” 27 TAX L. R. 325, 358-359 (1972). Such

criticism accords with the observation in Mr. Justice

Douglas’ dissent, that the majority holding “effectively

cancels §302(b)(1) from the Code”. United States v.

Davis, supra, 314.

It has been pointed out also that such holding leaves

unclear its applicability to redemptions by public com-

8

panies. Bacon, “Share Redemptions”, 26 TAX L. R. 283,

289 (1971).

(e) Here, as in Davis, stockholders acting under com-

pulsion of unquestioned business necessity, and with no

thought of tax avoidance, contributed to the capital of a

corporation. Once such necessity had abated, the precise

amount of their investment was returned to them, as orig-

inally contemplated, without increment or other economic

benefit.

The pertinent Treasury Regulation® specifies that ap-

plicability of section 302(b)(1) depends upon the facts

and circumstances of each case. However, the strict net

effect test of Davis ignores such circumstances as under-

lying business necessity and absence of tax avoidance

motives and treats as ordinary income the mere return

of one’s own money.

In the face of a legislative history, admittedly “not free

from doubt”, an interpretation which is not expressly

called for by the language of the statute itself ought not

produce such harsh and incongruous results. Mastro

Plastics Corp. v. NLRB, 350 U. 8. 270, 286 (1956).

3 Treasury Regulations on Income Tax (1954 Code):

§1.302-2 Redemptions not taxable as dividends.

(a) The fact that a redemption fails to meet the require-

— ments of paragraph (2), (3) or (4) of section 302(b) shall

not be taken into account in determining whether the re-

demption is not essentially equivalent to a dividend under

section 302(b)(1). * * *

(b) The question whether a distribution in redemption of

stock of a shareholder is not essentially equivalent to a divi-

dend under section mn) (3) vanes upon the facts and

circumstances of each case. *

Sha

9

(f) Stare decisis does not require “adherence to the lat-

est decision, however recent and questionable, when such

adherence involves collision with a prior doctrine more

embracing in its scope, intrinsically sounder, and verified

by experience.” Helvering v. Hallock, 309 U. 8. 106, 199

(1940); Boys Markets, Inc. v. Retail Clerks Union, 398

U. S. 235, 241 (1970).

2. This case presents an important policy question,

not raised or considered in United States v. Davis,

supra, affecting the just administration of the rev-

enue laws.

(a) In United States v. Davis, Inc., the Reconstruction

Finance Corporation and a Nashville, Tennessee bank

agreed to make a commercial loan to a newly-formed cor-

poration provided, inter alia, that the incorporators pro-

vided $25,000 of additional working capital either by loan

or purchase of stock.

In the case sub judice it was stipulated below that the

U. S. Maritime Commission granted a similar choice to

the stockholders of A & S. However, regulations promul-

gated by the Maritime Administration provide persuasive

evidence that controlling law, which must override a con-

trary fact stipulation, if there is any discrepancy between

the two, required that an additional contribution be made

to capital. Regulations, 4298.4(n), published in the Fed-

eral Register (23 F. R. 384) on January 22, 1958, as Gen-

eral Order 29, Revised, provides as follows:

(n) Net worth; mortgage and loan. To be eligi-

ble for loan and/or mortgage insurance, the appli-

cant shall submit evidence satisfactory to the Sec-

retary showing that at the time of execution of the

5 CESS Bttaategae: oR

x, ae ~— e oe ee

10

contract of insurance he will have net worth (equity

capital) composed of outstanding paid-in capital

stock or a paid-in surplus and/or earned surplus,

but not less than 50 per centum of which shall rep-

resent common stock equity, in an amount equal to

at least the following:

(1) Complement of the mortgage, e.g. 25 per cen-

tum or 12% per centum, as the case may be, of

“actual cost” as determined in accordance with §

298.7(a), or of the loan (if not to be replaced by a

mortgage), e.g. 25 per centum of “actual cost” as

determined in accordance with §298.7(a).

(2) Plus, in the case of a mortgage, one pro rata

portion of the proposed original principal amount

of the mortgage, e.g. 1/20th on a twenty-year mort-

gage or 1/10th on a ten-year mortgage, etc.

(3) Plus, any additional amount determined by

the Secretary to be necessary by reason of other

activities of the applicant not covered by para-

graph (0) of this section.

The authority of grant Federal Ship Mortgage Insur-

ance, and to promulgate the foregoing regulation in con-

nection therewith is set forth in Subchapter XI of the

Merchant Marine Act of 1936, as Amended, 46 U.S.C.

§1271 et seq.

Section 1278 (46 U.S.C. $1278) provides as follows:

§1278 Rules & Regulations

The Secretary of Commerce is authorized and di-

rected to make such rules and regulations as may

be deemed necessary or appropriate to carry out

the purposes and provisions of this subchapter.

11

After successfully operating the “Dykes” between 1945

and 1958, A & S required a new barge to stay in business.

Without a loan insured by the Maritime Administration

pursuant to Chapter XI of the Merchant Marine Act of

1936, as amended, A & S would not have been able to ac-

quire a new barge. And unless the taxpayers had com-

plied, as they did, with the equity capital requirements of

Regulations, §298.4(n), A & S could not have qualified for

Federal Ship Mortgage Insurance. When in 1965, the

ship loan had been paid off, the taxpayers got their money

—no more, no less—back again.

(b) Now, the government says, and the courts below,

deeming Davis to control, have agreed, that although the

taxpayers acted in good faith, and in a real sense, under

compulsion of Federal law, they must treat the return of

their own money as a taxable dividend and pay a tax

thereon.

This Court, whose ultimate aim is justice, should not

permit such an incongruous result to stand; and specifi-

cally should not authorize an interpretation of the tax

laws which permits one arm of the government to levy

taxes on those who without economic gain to themselves

have complied with the statutorily authorized regulations

of another arm of the same government.

(c) The foregoing contention was neither presented to,

nor considered by the Supreme Court in United States

v. Davis, supra. Perhaps the facts there, and specifically

the absence of any mandatory requirement such as that

prescribed in Regulations, §298.4(n), supra, did not per-

mit the presentation of such an argument. However, a

basis for distinguishing this case from United States v.

Davis, supra, as a matter of law, not to mention equity

and conscience, is provided here.

12

CONCLUSION

For the foregoing reasons the petition for a writ

of certiorari should be granted.

Respectfully submitted,

Martin D. CoHEN

Suite 1901

744 Broad Street

Newark, New Jersey 07102

Attorney for Petitioners

APPENDIX A

Official Findings of Fact and Opinion of the United

States Tax Court

(Filed June 21, 1971, and officially reported

at 56 T.C. 556)

QueaLy, Judge: The respondent determined deficiencies

in the Federal income taxes due from the petitioners as

follows:

Docket No. Year Deficiency

405-70 1965 $7,679.52

[Joseph Miele] 1966 8,386.20

421-70 1965 7,354.70

[V. James & Gloria Spiniello] | 1966 6,054.23

422-70 1965 5,799.74

[Anthony P. & Maria E. Miele] 1966 6,417.35

423-70 ' 1965 5,777.85

[Luke C. & Grace Spiniello] 1966 5,073.45

The issues presented for decision are:

(1) As to all dockets, whether petitioners, who own

100 percent of the voting stock of a corporation, are re-

quired to treat the prorata redemption of nonvoting stock

held in proportion to their common stock holding as a

dividend rather than as a return of capital.

(2) eee

*** Portions of the Tax Court’s findings of fact and opinion, re-

lating to an issue not involved herein, have been omitted; and such

omissions are indicated by asterisks.

[1a]

2a

Appendia A

Some of the facts have been stipulated. The stipula-

tion of facts and exhibits attached thereto are incorpo-

rated herein by this reference.

Joseph Miele, petitioner in docket No. 405-70, is an

individual residing in West Orange, N. J. Anthony P.

Miele and Maria E. Miele, petitioners in docket No. 422-

70, are individuals, husband and wife, also residing in

West Orange, N. J.

V. James Spiniello and Gloria Spiniello, petitioners in

docket No. 421-70, are individuals, husband and wife, re-

siding in Short Hills, N. J. Luke C. Spiniello and Grace

Spiniello, petitioners in docket No. 423-70, are individuals,

husband and wife, also residing in Short Hills, N. J.

Petitioner Joseph Miele filed individual income tax re-

turns for the taxable years 1965 and 1966 with the dis-

trict director of internal revenue, Newark, N. J. Peti-

tioners Anthony and Maria Miele, V. James and Gloria

Spiniello, and Luke C. and Grace Spiniello filed joint in-

come tax returns with the district director of internal

revenue, Newark, N. J. ‘All of the returns were filed on

the cash basis.

Maria E. Miele, Gloria Spiniello, and Grace Spiniello

are parties to this proceeding solely by virtue of the joint

income tax returns which they filed with their respective

hifsbands for the taxable years here involved.

I. Findings Related to the Preferred Stock

Redemption Issue

A & S Transportation Co. (hereinafter referred to as

“4 & S”) was incorporated under the laws of New Jersey

on January 17, 1945. The original authorized capital of

3a

Appendia A

A & S, as provided for in its certificate of incorporation,

consisted of 1,000 shares of common stock having a par

value of $100 per share.

For some time prior to April 1959, there were 132 is-

sued and outstanding shares of A & S common stock (as

described above) which were held as follows:

Joseph Miele 21 Joseph LaFera, Sr. 1

Anthony Miele 21 Joseph LaFera, Jr. 1

Luke Spiniello LaFera Coal & Con-

struction Co., Inc. 42

2

21

James Spiniello 22 Virgilio Spiniello

J. Franklyn Ficken 2 (Father of James

; & Luke)

On June 23, 1949, J. Franklyn Ficken sold and assigned

his 2 shares of A & S stock to Joseph and Anthony Miele.

The said 2 shares were transferred to Richard J. Miele,

son of Anthony Miele, on August 26, 1962. Virgilio Spin-

iello died on January 20, 1962, bequeathing by will his

share? of A & S stock to Luke Spiniello, who has since

held a total of 22 shares.

LaFera Coal and Construction Co. was an equipment

rental company owned by Joseph LaFera, Sr. and Joseph »

LaFera, Jr. On October 1, 1962, LaFera Coal and Con-

struction Co. became a wholly owned subsidiary of La-

2The stipulation of facts specifies that only 1 share was be-

queathed by Virgilio to Luke although the stipulation also specifies

that Virgilio held 2 shares and does not set forth the disposition

of the remaining share.

4a

Appendia A

Fera Contracting Co. (hereinafter referred to as “Con-

tracting”) in a tax-free reorganization. Thereafter, on

September 3, 1963, LaFera Coal and Construction Co.

was liquidated in accordance with a plan adopted on Au-

gust 30, 1963, and Contracting succeeded to all of. the

assets of LaFera Coal and Construction Co., including

the 47 shares of A & S stock which it held.

At all times since its incorporation, A & S has been

engaged in the business of moving sludge out to sea by

means of one or more seagoing barges. For some time

prior to April 1959, A & S carried on its business activi-

ties by the operation of a single barge called the “Dykes”.

By approximately 1956, the “Dykes” was in such a poor

state of repair that maintenance costs were exceeding the

value of the vessel. At a meeting of the Board of Di-

rectors of A & S held on September 15, 1957, it was

noted that key employees of A & S had accepted notes in

lieu of salary in order to free funds for the repair of

the “Dykes”.

The Management of A & S ascertained that a new

vessel to replace the “Dykes” would cost approximately

$545,000. Since A & S could not afford to make such a

purchase without financing from outside sources, it en-

tered into negotiations with the United States Maritime

Commission (hereinafter sometimes referred to as the

“Maritime Commission” or the “Commission”). This

Commission, in furtherance of public policy was empow-

ered by applicable law to guarantee, in proper cases, fully

secured first mortgage loans made to domestic shipping

companies to finance the purchase of seagoing vessels.

The Maritime Commission advised A & S that at least

$150,000 of additional capital from private sources would

5a

Appendix A

have to be invested in the corporation before the loan

could be guaranteed. The Maritime Commission also ad-

vised A & S that this requirement of additonal private

capital could be satisfied in either of the following ways:

(1) An unsecured loan for $150,000 which would be sub-

ordinated to the loan to be guaranteed by the Maritime

Commission or

(2) The issuance of non-voting, non-dividend paying,

non-cumulative preferred stock, having an aggregate par

value of $150,000, which could not be redeemed until after

full payment of the proposed first mortgage loan.

The principals of A & S, including Anthony and Vir-

gilio Spiniello, preferred the alternative of making an un-

secured loan. However, they accepted the opinion of their

advisor (one Samuel Klein, an attorney and certified pub-

lic accountant) that the issuance of preferred stuck would

accomplish their entire purpose in the shortest time, and

on March 30, 1959, by action of its board of directors, the

certificate of incorporation of A & S was amended in per-

tinent part to provide as follows:

* * * The total authorized capital stock of this

corporation is Two Hundred Fifty Thousand ($250,-

000.00) Dollars, divided into three hundred (300)

shares of preferred stock, of a par value of Five

Hundred ($500.00) Dollars each, and One Thousand

shares of common stock of the par value of One

Hundred ($100.00) Dollars each.

The preferred stock shall be non-voting, non-divi-

dend and non-cumulative and shall be redeemed by

the corporation in full at par value ten years after

April 15, 1959, and may be redeemed by the cor-

poration at par value on or after July 15, 1964.

6a

Appendiz A

On April 13, 1959, A & S issued preferred stock to its

common shareholders for cash as follows:

Number

of Shares Issued to Par Value

50 Joseph Miele $ 25,000

50 Anthony Miele 25,000

50 Luke C. Spiniello 25,000

50 V. James Spiniello 25,000

100 LaFera Coal and

Construction Co. 50,000

300 Total $150,000

The preferred stock certificates were stipulated to be

“non-voting, non-dividend paying, non-cumulative,” and

were required “to be redeemed no later than 10 years

after date of issuance”. The preferred stock could also be

redeemed prior to the expiration of this 10-year period

but only after July 15, 1964, the prospective maturity date

of the pending bank loan. A & S represented the certi-

ficeates as preferred stock to the Maritime Commission,

and A & S did not show the amounts received for the pre-

ferred stock as a loan in its tax returns.

On July 17, 1959, the board of directors of A & S au-

thorized a bank loan of $380,000 to be secured by a first

preferred ship mortgage oa the sludge barge “Judson K.

Stickle” which was io be purchased as a replacement for

the “Dykes”. The loan was to be repayable in 60

equal consecutive monthly installments of $5,000 and

a final “balloon” payment of $80,000. Interest, payable

monthly, was to be at the rate of 5 percent per annum.

Ta

Appendiz A

The $380,000 bank loan was consummated on July 31,

1959, on essentially the terms set out above. The first

preferred ship mortgage, which A & S executed on this

same date, had a stated maturity date of August 31, 1964.

The mortgage expressly prohibited the payment of any

dividend or repayment of an indebtedness to a stockhold-

er “so long as this Mortgage and any installment of the

Mortgage Note is outstanding, * * *”.

The sludge barge “Judson K. Stickle” was delivered to

A & S on July 31, 1959. Thereafter, A & S operated the

“Judson K. Stickle” and made the payments due under

the mortgage not given by A & S at the closing, the last

of such payments being made on or about August 31,

1964.

On May 14, 1965, the board of directors of A & S, at

the insistence of the shareholders, resolved to redeem 150

shares of the preferred stock from the holders of record

in proportion to their holdings. On or about May 14,

1965, A & S, pursuant to this resolution, acquired one-

half of the preferred stock from its shareholders:

Number Amount Paid

of Shares by AES

Shareholder Redeemed For the Stock

8a

Appendiz A

On or about January 2, 1966, the board of directors of

& S, again at the insistence of the shareholders, re-

solved to redeem the remaining 150 shares of preferred

stock. On or about January 2, 1966, A & S, pursuant to

this resolution, acquired the remaining one-half of the

Number Amount Paid

of Shares by AES

Shareholder Redeemed For the Stock

50

Luke C. Spiniello 25

V. James Spiniello 25

Joseph Miele 25 12,500

Anthony P. Miele 25

150

.

Total

Unrmate Foxprves or Fact

1. Preferred Stock Redemption Issue

(a) The preferred stock issued by A & S and later re-

deemed in accordance with the terms of the stock certifi-

eate was preferred stock and not evidence of indebted-

ness.

(b) The pro rata distributions made by A & S in re

demption of its preferred stock were essentially equiva-

lent to a dividend and do not qualify as a distribution or

payment in exchange for stock under section 302(a).*

—

3 All statutory references are to the Internal Revenue Code of

, mended, unless otherwise indicated.

9a -

Appendiz A

Opnrion

IL. Questions with Respect to the Stock Redemption by

A & 8 Corporation

A & S engaged in the business of operating a seagoing

barge. In 1959, A & S decided to purchase a new barge

and entered into negotiations to finance the acquisition.

One aspect of the negotiations included obtaining a guar-

antee by the United States Maritime Commission of a

fully secured first mortgage loan. The Maritime Commis-

sion advised A & S that at least $150,000 of additional

capital from private sources would have to be invested in

the corporation before the loan could be guaranteed.

The Maritime Commission posed two alternatives for

providing for the additional capital:

(1) An unsecured loan subordinated to the guaranteed

note or

(2) An issue of preferred stock.

The board of directors of A & S adopted the alternative

of issuing preferred stock as the means of investing the

additional capital. The stockholders invested in the newly

created preferred stock in proportion to their holdings in

the common stock of A & S. As a result of this additional

capital, the Maritime Commission guaranteed the first

mortgage loan thus enabling A & S to acquire a new

barge.

A & S took possession of the new barge on July 31,

1959. Thereafter it operated the barge and amortized the

note guaranteed by the Maritime Commission making the

final payment on or about August 31, 1964.

10a

Appendix A

On May 14, 1965, the board of directors of A & 5S, at

the insistence of the shareholders, decided to redeem one-

half of the outstanding preferred stock in proportion to

the ownership thereof. On January 2, 1966, the balance

of the preferred stock was redeemed. The redemptions

were pro rata, and after each redemption the shareholders

occupied exactly the same relationship with respect to the

ownership of A & S as they did before the redemption.

Initially, the petitioners contend that the “preferred

stock” in this case was evidence of debt and not equity.

We cannot accept this argument.

No all encompassing rule has been evolved and accepted

for application in all cases to determine whether the obli-

gations in question in a particular case are evidence of

equity investment in the corporations involved or are evi-

dence of indebtedness. It is clear that no single charac-

teristic is determinative in all cases and that the basic

question of whether the holders of the obligations are

stockholders or creditors must be determined by an an-

alysis of all relevant factors. John Kelly Co. v. Com-

missioner, 326 U. S. 521 (1943); Ragland Investment Co.,

52 T.C. 867 (1969).

The Martime Commission required that $150,000 of ad-

ditional capital be invested in A & S before the Commis-

sion would guarantee the loan for the acquisition of a

new barge. The Maritime Commission gave the petition-

ers the alternatives of either a loan or an issue of pre-

ferred stock as the means of providing for this addition-

al capital. Thus, the petitioners were in a position to

control the nature of the investment. They chose the

preferred stock or equity investment over the debt method

of financing, and having made this choice, petitioners can-

lla

Appendix A

not escape from the statutory consequences of their deci-

sion by arguing that the transaction could have been ar-

ranged in another way with different consequences. Wise-

man v. United States, 371 F. 2d 816 (C. A. 1, 1967);

(C. A. 9, 1942); Comimssioner v. Kolb, 100 F. 2d 920

(C. A. 9, 1938); Cf, Gray v. Powell, 314 U. &. 402, 414

(1941).

In addition, there are numerous other factors which in-

dicate that the certificates in question represent equity

and not debt. The certificates were labeled, structured, and

repeatedly referred to throughout as preferred stock.

While the name given to a security is not necessarily de-

terminative in regards to its nature, the nomenclature

used by the parties is a factor which cannot be ignored.

Crawford Drug Stores v. United States, 220 F. 2d 299

(C. A. 10, 1955); John Wanamaker Philadelphia v. Com-

missioner, 139 F. 2d 644 (C. A. 3, 1943); First Mortgage

Corp. v. Commissioner, 135 F. 2d 121 (C. A. 3, 1943).

The attorney-adviser for A & S, Samuel Klein, readily

admitted to the Court that if the corporation went into

receivership, the holders of the certificates here in ques-

tion could not file claims as creditors.* -Since it is a

*Under New Jersey law, it is apparent that the certificates in

question would be classified as preferred stock. See Hilson Co.

N. J. Eq. 475, 25 A. 2d 874 (Ct. Ch. N. J. 1942). Thus, the

certificates did not establish debt but only created a preference for

12a

‘Appendia A

normal characteristic of a ereditor relationship that the

creditors share in the assets of a corporation before the

stockholders (the preferred stockholders sharing in the

assets before any other class of stock) or any other group

in the event of a liquidation or dissolution of the cor-

poration, the rights of the holders of the certificates in

question herein are in essence subordinated to the rights

of the general creditors of the A & S corporation. This

factor of subordination is generally regarded as indica-

tive of an equity as opposed to a ereditor interest. Mu-

waukee & Suburban Transport Corporation v. Commis-

sioner, 283 F. 2d 279 (C. A. 7, 1960); certiorari denied

366 U. S. 965 (1961), remanded on another issue 367 U. S.

906 (1961); John Wanamaker Philadelphia v. Commis-

sioner, supra; First Mortgage Corp. v. Commissioner,

supra.

If a creditor-debtor relationship had been intended, it

would have only been necessary for the board of direc-

tors of A & S to authorize the execution of bonds or

notes. It would not have been necessary for the board to

amend the certificate of incorporation of A & S to pro-

vide for an increase in the amount of authorized capital

steck. The fact that the board of directors of A & S

took this latter action tends to indicate that the board

intended to create additional capital stock or equity. John

Wanamaker Philadelphia v. Commissioner, supra.

The certificates in question did not provide for the

payment of any interest, and we consider this absence of

an interest element as indicating that the purported debt

was in reality a capital contribution. Road Materials,

Inc. v. Commissioner, 407 F. 2d 1121 (C. A. 4, 1969);

Curry v. United States, 396 F. 2d 630 (C. A. 5, 1968), cer-

tiorari denied 393 U. S. 967 (1968); Alfred R. Bachrach,

18 T. C. 479 (1952), affd. 205 F. 9d 151 (C. A. 2, 1953).

13a

Appendiz A

Furthermore, the purported debt in this case was held

by the petitioners in proportion to their respective stock-

holdings. While such proportionality by itself is not

sufficient to establish the purported debt is in fact equity.

Piedmont Corporation v. Commissioner, 388 F. 2d 886,

889 (C. A. 4, 1968), and Liflans Corporation v. United

States, 390 F. 2d 965, 971 (Ct. Cl. 1968), it is a factor

which is indicative of an equity interest as opposed to a

debt interest. Charter Wire, Inc. v. United States, 309

F. 2d 878 (C. A. 7, 1962); P. M. Finance Corporation v.

Commissioner, 302 F. 2d 786 (C. A. 2, 1957).

When A & S sought to demonstrate to the United

States Maritime Commission that it had provided for

the increase in the equity interest in the corporation

which the Commission had requested, the certificates in

question were represented to the Commission as preferred

stock. Such a representation is indicative of an inten-

tion to create equity and not debt. Milwaukee & Suburban

Transport Corporation v. Commissioner, supra. See also

Lee Telephone Co. v. Commissioner, 260 F. 2d 114 (C. A.

4, 1958).

In addition, A & S did not show the amounts it re-

ceived for the issuance of its preferred stock as a loan

on its tax return. We consider such corporate treatment

of the amounts involved as evidence of the fact that the

certificates were equity and not debt. Cf. First Mortgage

Corp. v. Commissioner, supra at 123, 124 (where the fail-

ure of the corporation to follow the usual- procedures

associated with debt was considered as evidence that debt

was not intended), and Byerlite Corporation v. Williams,

286 F. 2d 285, 290 (C. A. 6, 1960) (where the corporate

treatment of amounts received was regarded as evidence

of whether or not there was an intention to create a

debt).

léa

Appendiz A

The existence of a definite maturity date is a significant

factor indicating the existence of a debtor-creditor rela-

tionship. Wood Preserving Corporation of Baltimore v.

United States, 347 F. 2d 117, 119 (C. A. 4, 1965); Pari

sian, Inc. v. Commissioner, 131 F. 2d 394 (C. A. 5, 1942) ;

Commissioner v. Schmoll Fils Associated, 110 F. 2d 611,

613 (C. A. 2, 1940); see also section 385(b) (1), LR.C. 1954,

added by section 415(a) of the Tax Reform Act of 1969.

While the certificates in question do have such a definite

maturity date in that they must be redeemed at the end

of a specified period of time, we do not consider this as

conclusive of the character of the certificates, Consumers

Credit Rural Electric Coop. Corp. v. Commissioner, 319

F. 2d 475 (C. A. 6, 1963); Crown Iron Works Co. v.

Commissioner, 245 F. 2d 357 (C. A. 8, 1957); Kentucky

River Coal Corporation, 3 B. T. A. 644 (1926), as it is

not unusual for preferred stock to have a maturity date.

Charles L. Huisking & Co., 4 T. C. 595, 599 (1945).

Rather, we have weighed this factor with all other fac-

tors present in this case, and we hold that the indicia of

equity predominate with certainty. Accordingly, we have

concluded that the certificates in question were in fact

preferred stock as opposed to evidence of indebtedness.

Having disposed of petitioner’s initial contention, we

must now consider their second argument. The petitioners

stress that the preferred stock was issued because the

Maritime Commission required them to invest an addi-

tional $150,000 of capital in the corporation as a condi-

tion precedent to its guaranteeing of the loans which were

necessary to enable A & S to finance the acquisition of

a new barge. They argue 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 busi-

ness purpose for which the stock was issued. On this

15a

' Appendia A

basis, they conclude that the redemption transaction was

within the protection of section 302(b)(1).

We consider this argument as having been foreclosed

and the issue determined by the case of United States v.

Davis, 397 U. 8. 301 (1970). In Davis, the United Statés

Supreme Court held that a redemption without a change

in the relative economic interests or rights of the stock-

holders is always essentially equivalent to a dividend

under section 302(b)(1). It is the effect of the redemp-

tion and not the purpose behind it which is determinative

of dividend equivalence. See also Hasbrook v. United

States, 343 F. 2d 811 (C. A. 2, 1965); Kessner v. Commis-

stoner, 248 F. 2d 943 (C. A. 3, 1957); and Ray A. Maher,

55 T. C. 441 (1970). Hence, we hold that in this case,

where the redemption of the preferred stock of A & S

in two equal installments did not change the relative eco-

~ pomic interests, control, or rights of the stockholders

f (the petitioners herein), the redemption was essentially

equivalent to a dividend and does not qualify as a dis-

tribution or payment in exchange for the stock.

f

Decisions will be entered

for the respondent in docket

Nos. 405-70 and 422-70.

Decisions will be entered

under Rule 50 in docket Nos.

421-70 and 423-70.

ee seneen oe acerecontaeaneeineaeed —

-l6a

APPENDIX B

T. C. Memo. 1971-161

Untrep States Tax Court

>

__

LaFera Contractinc Company,

Petitioner,

v. (

CoMMISSIONER OF INTERNAL REVENUE,

Respondent.

Docket No. 424-70

» =

—~—

Filed July 12, 1971

[Appearances of counsel omitted]

MemoranpuM Finprnes or Fact anp OPINnion

Queaty, Judge: The respondent determined a deficiency

in petitioner’s income tax for the taxable year ended Sep-

tember 30, 1964 in the amount of $5,214.02.

Other issues having been previously disposed of, the

parties filed a stipulation at trial in which the petitioner

conceded the respondent’s disallowance of the petitioner’s

claimed salary deductions.

17a

Appendix B

This stipulation of the parties also sets forth their

agreement concerning the disposition of a preferred stock

redemption issue. They agreed that with respect to this

issue, they would be bound by the ultimate judicial deter-

mination in the consolidated trial of Joseph Miele, et al.,

56 T. C. No. 45. (Docket Nos. 405-70, 421-70, 422-70,

423-70). In the Miele case, we found and held that the

preferred stock redemptions were essentially equivalent

to a dividend and did not qualify as a distribution or

payment in exchange for stock under section 302(a).

Therefore in accordance with the stipulation of the par-

ties, we hold the preferred stock redemptions in question

in the instant case were essentially equivalent to a divi-

dend and do not qualify for section 302(a) treatment.

Decision will be entered

under Rule 50.

-18a

APPENDIX C

Judgment Order

Unrrep States Court or APPEALS

For tHe Txuirp Circuit

Nos. 72-1031 and 72-1032

™

—_

is JoserH MIELE,

Appellant,

v.

ComMMISSIONER OF INTERNAL REVENUE,

Appellee.

(Tax Court Docket No. 405-70)

Antuony P. Miete and Mari E. Miete,

Appellants,

Vv.

CoMMISSIONER OF INTERNAL REVENUE,

Appellee.

(Tax Court Docket No. 422-70)

7

~~

Submitted Under Third Circuit Rule 12(6)

January 29, 1973

Se

19a

Appendia C

Before Serrz, Chief Judge, Aupisert, Circuit Judge.

After reviewing appellants’ contentions, and finding the

case controlled by the decision of the United States Su-

preme Court in United States v. Davis, 397 U. 8. 301

(1970), it is

OrpERED anp Apsupcrp that the judgment of the Tax

Court of the United States is affirmed.

Costs taxed against appellants.

By the Court,

Comus J. Serm

Chief Judge

Attest:

Tomas F. Quinn

Clerk

Dated: January 30, 1973

. 20a

Appendia C

Iw THE

Unrrep Sratres Court or APPEALS

For tae Tarp Crecuir

Nos. 72-1254, 72-1255 and 72-1368

V. James Sprvrecvo and Grorm Sprvie.1o,

Appellants,

v.

ComMiIssiONER OF INTERNAL REVENUE,

Appellee.

(Tax Court Docket No. 421-70)

Luxe C. Senecio and Grace SprniE.1,

Appellants,

v.

CoMMISSIONER OF INTERNAL REVENUE,

Appellee.

(Tax Court Docket No. 423-70)

™

7

2la

Appendiz C’

-

-

LaFera Contractrne Company,

Appellant,

v.

Commissioner oF InTERNAL REVENUE,

Appellee.

(Tax Court Docket No. 424-70)

i

a

Present: Serrz, Chief Judge, and Aupisert, Circuit Judge.

JUDGMENT ORDER

A joint stipulation of the parties in the above-entitled

cases was granted by the Clerk on May 18, 1972, provid-

ing that the determination of this Court with respect to

the issues presented in Docket Nos. 72-1031 and 72-1032

(Joseph Miele, et al. v. Commissioner) shall be disposi-

tive of appellants’ respective appeals herein. In accord-

ance with that stipulation and with the Judgment Order

entered January 30, 1973, in Nos. 72-1031 and 72-1022, it

is OnpERED anp Apsupcep that the decisions of the United

States Tax Court in the above-captioned cases are af-

firmed.

By the Court,

Couzms J. Serm

Chief Judge

Dated: April 11, 1973

Attest:

Tomas F. Quixw

Clerk

. 22a

APPENDIX D

Order of the United States Tax Court

Unrrep Srares Tax Court

WasHINGTON

Docket No. 405-70

A

7

JosePH MIEzLE,

Petitioner,

v.

ComMissioneR OF INTERNAL REVENUE,

Respondent.

ip

.

OrpDER

Upon consideration of counsel for petitioner’s motion

to substitute parties and change caption filed April 25,

1973, in which it is represented that respondent has no

objection, it is

Ornverep that the motion is granted and the caption of

this case is amended to read “Estate of Joseph Miele, De-

_ceased, Norman E. Albers, Nicholas Joya and Horace D.

Marucci, Executors, petitioners, v. Commissioner of In-

ternal Revenue, respondent”.

(Signed) W. M. Daennen

Judge

Dated: Washington, D. C.

May 8, 1973