FULMAN v. UNITED STATES(1978)
The provision of Treas. Reg. 1.562-1 (a) that a personal holding company's distribution of appreciated property to its shareholders results, under 561 and 562 of the Internal Revenue Code of 1954, in a dividends-paid deduction limited to an amount that is the adjusted tax basis of the property in the hands of the company at the time of the distribution held valid as having a reasonable basis, as against the contention that such deduction should be equal in amount to the fair market value of the property distributed. Given the fact that 27 (d) of the Internal Revenue Code of 1939 expressly provided the "adjusted basis" measure for valuation of dividends paid in appreciated property rather than money, and the ambiguity surrounding the legislative history of 562 of the 1954 Code, which sets forth the rules applicable in determining dividends eligible for the dividends-paid deduction but contains no counterpart to 27 (d) of the 1939 Code, no "weighty reason" justifying setting aside the regulation in question can be identified. Pp. 530-539.
545 F.2d 268, affirmed.
BRENNAN, J., delivered the opinion of the Court, in which BURGER, C. J., and STEWART, WHITE, MARSHALL, and REHNQUIST, JJ., joined. STEVENS, J., filed an opinion concurring in the judgment and concurring in part, post, p. 539. POWELL, J., filed a dissenting opinion, post, p. 539. BLACKMUN, J., took no part in the consideration or decision of the case.
Daniel D. Levenson argued the cause and filed briefs for petitioners.
Michael L. Paup argued the cause for the United States. With him on the brief were Acting Solicitor General Friedman, Assistant Attorney General Ferguson, Stuart A. Smith, and Joseph L. Liegl. [434 U.S. 528, 529]
Mr. JUSTICE BRENNAN delivered the opinion of the Court.
The question presented in this case is the validity of the provision of Treas. Reg. 1.562-1 (a), 26 CFR 1.562-1 (a) (1977), that a personal holding company's distribution of appreciated property to its shareholders results, under 561 and 562 of the Internal Revenue Code of 1954, 26 U.S.C. 561 and 562, in a dividends-paid deduction limited to an amount that is "the adjusted basis of the property in the hands of the distributing corporation at the time of the distribution." 1 The Court of Appeals for the First Circuit sustained the validity of the provision in this case, 545 F.2d 268 (1976), disagreeing with the Court of Appeals for the Sixth Circuit in H. Wetter Mfg. Co. v. United States, 458 F.2d 1033 (1972), which had concluded that the limitation on the dividends-paid deduction is invalid and that a personal holding company is entitled to a deduction equal in amount to the fair market [434 U.S. 528, 530] value of property distributed. 2 We granted certiorari to resolve the conflict. 431 U.S. 928 (1977). We agree with the Court of Appeals for the First Circuit that the limitation on the dividends-paid deduction provided by the regulations is valid, and therefore affirm its judgment.
The maximum income tax rate applied to corporations has for many years been substantially below marginal tax rates applicable to high-income individuals. As early as 1913, Congress recognized that this disparity provided an incentive for individuals to create corporations solely to avoid taxes. In response Congress imposed a tax on the shareholders of any corporation "formed or fraudulently availed of" for the purpose of avoiding personal income taxes. Tariff Act of 1913, II-A, Subdivision 2, 38 Stat. 166; see Ivan Allen Co. v. United States, 422 U.S. 617, 624 -625, and n. 8 (1975). Section 220 of the Revenue Act of 1921, 42 Stat. 247, shifted the incidence of this tax to the corporation itself, where it has remained to this day. See Ivan Allen Co. v. United States, supra, at 625 n. 8.
Early statutes designed to combat abuse of the corporate form were not notably successful, however, and in 1934 Congress concluded that the "incorporated pocketbook" - a closely held corporation formed to receive passive investment property and to accumulate income accruing with respect to that property - had become a major vehicle of tax avoidance. 3 [434 U.S. 528, 531] Congress' response was the personal holding company tax, enacted in 1934, and now codified as 541-547 and 561-565 of the Internal Revenue Code of 1954, 4 26 U.S.C. 541-547 and 561-565 (1970 ed. and Supp. V).
The object of the personal holding company tax is to force corporations which are "personal holding companies" 5 to pay in each tax year dividends at least equal to the corporation's undistributed personal holding company income - i. e., its adjusted taxable income less dividends paid to shareholders of the corporation, see 545 - thus ensuring that taxpayers cannot escape personal taxes by accumulating income at the corporate level. This object is effectuated by imposing on a personal holding company both the ordinary income tax applicable to its operation as a corporation and a penalty tax of 70% on its undistributed personal holding company income. See 541, 545, 561. Since the penalty tax rate equals or exceeds the highest rate applicable to individual taxpayers, see 26 U.S.C. 1 (1970 ed. and Supp. V), it will generally be in the interest of those controlling the personal holding company to distribute all personal holding company income, thereby avoiding the 70% tax at the corporate level by reducing to zero the tax base against which it is applied. 6
Petitioners are the successors to Pierce Investment Corp. In 1966 the Commissioner audited Pierce and determined that it was a personal holding company for the tax years 1959, 1960, [434 U.S. 528, 532] 1962, and 1963. Deficiencies in personal holding company taxes of $26,571.30 were assessed against Pierce. In response to the audit, Pierce entered an agreement with the Commissioner pursuant to 547 of the Code which provides that a corporation in Pierce's position may enter such an agreement, acknowledging its deficiency and personal holding company status, and may within 90 days thereafter make "deficiency dividend" payments that become a deduction against personal holding company income in the years for which a deficiency was determined and reduce that deficiency. Shares of stock Pierce held in other companies were promptly distributed as deficiency dividends. The fair market value of this stock at the time of distribution is agreed to have been $32,535; its adjusted tax basis, $18,725.11.
Pierce then filed a claim for a deficiency-dividend deduction, as required by 547 (e), indicating that the value of dividends distributed for the tax years in question was $32,535. The Commissioner, relying on Treas. Reg. 1.562-1 (a), allowed this claim only to the extent of Pierce's adjusted basis in the stock, and he determined a new deficiency after reducing Pierce's personal holding company income by the amount of the deficiency dividends allowed. Pierce paid this tax and the Commissioner denied its claim for a refund.
Petitioners as Pierce's successors thereafter brought a refund suit in the United States District Court for the District of Massachusetts, arguing that the deficiency dividends should have been valued at their fair market value. The District Court on cross-motions for summary judgment denied relief, 407 F. Supp. 1039 (1976), and the Court of Appeals for the First Circuit affirmed. Each court found the Treasury Regulation to be a reasonable interpretation of the personal holding company tax statute, and each expressly refused to follow the contrary holding of H. Wetter Mfg. Co. v. United States, supra. 7 Accordingly a refund was denied. [434 U.S. 528, 533]
Petitioners suggest that the way out of this circularity is to adopt the valuation rules for distributions of property found in 301 of the Code, 26 U.S.C. 301. We cannot agree, for 301 deals not with the problem of valuing the distribution with respect to the distributing corporation, but establishes rules governing the valuation with respect to distributes. This is not to deny the logical force of petitioners' argument that, since the purpose of the personal holding company tax is to force individuals to include personal holding company income in their individual returns, the corporate distributor should get a deduction at the corporate level equal to the income generated by the distribution at the shareholder level as defined by 301, that is, the fair market value of the appreciated property in this case. 9 See 26 U.S.C. 301 (b) [434 U.S. 528, 535] (1) (A). Indeed, H. Wetter Mfg. Co. v. United States, 458 F.2d 1033 (1972), and Gulf Inland Corp. v. United States, 75-2 USTC § 9620 (WD La.), appeal docketed, No. 75-3767 [434 U.S. 528, 536] (CA5 1975), have taken the view urged by petitioners, and but for the Regulation, the argument might well prevail. 10 But, as we have indicated, the issue before us is not how we might resolve the statutory ambiguity in the first instance, but whether there is any reasonable basis for the resolution embodied in the Commissioner's Regulation. We conclude that there is.
In the Revenue Act of 1936, Congress enacted a surtax on undistributed profits intended to supplement the 1934 enactment of the personal holding company tax. In 27 (c) of the 1936 Act, 49 Stat. 1665, later codified as 27 (d) of the Internal Revenue Code of 1939, 53 Stat. 20, Congress expressly provided the "adjusted basis" measure for valuation with respect to the distributing corporation of dividends paid in appreciated property rather than money:
The relevant provisions of the 1936 Revenue Act were carried over without material change into the Internal Revenue Code of 1939. See 27 (d), 115 (j), of that Code, 53 Stat. 20, 48. Thus, the logical symmetry between the gain recognized at the shareholder level and the dividend credit allowed at the corporate level, which petitioners argue should be the touchstone for our decision, was not part of the scheme of the Internal Revenue Code from 1936 to 1954.
Nor can Congress' failure to re-enact a counterpart to 27 (c) in the 1954 Code be read unambiguously to indicate that Congress had abandoned the "adjusted basis" measure in favor of the "fair market value" measure. In describing the purpose of 562 (a), which defines dividends eligible for deduction for personal holding company tax purposes, the Senate Finance Committee explained:
At the least, it is not unreasonable for the Commissioner to have assumed that Congress intended to carry forward the law existing prior to the 1954 Code with respect to the measure of valuation. As we said in United States v. Ryder, 110 U.S. 729, 740 (1884): "It will not be inferred that the legislature, in revising and consolidating the laws, intended to change their policy, unless such intention be clearly expressed." Accord, Aberdeen & Rockfish R. Co. v. SCRAP, 422 U.S. 289, 309 n. 12 (1975); Muniz v. Hoffman, 422 U.S. 454, 467 -472 (1975); Fourco Glass Co. v. Transmirra Corp., 353 U.S. 222 , [434 U.S. 528, 539] 227 (1957). If we will not read legislation to abandon previously prevailing law when, as here, a recodification of law is incomplete or departs substantially and without explanation from prior law, we cannot conclude that the Commissioner may not adopt a similar rationale in drafting his rule. 15 In any case, given the law under the 1939 Code and the ambiguity surrounding the House and Senate Reports on 562, it is impossible to identify in this case any "weighty reasons" that would justify setting aside the Treasury Regulation.
[ Footnote 2 ] Accord, Gulf Inland Corp. v. United States, 75-2 USTC § 9620 (WD La.), appeal docketed, No. 75-3767 (CA5 1975). But see C. Blake McDowell, Inc. v. Commissioner, 67 T. C. 1043 (1977).
[ Footnote 3 ] See H. R. Rep. No. 704, 73d Cong., 2d Sess., pt. 1, pp. 11-12 (1934); Subcommittee of House Committee on Ways and Means, 73d Cong., 2d Sess., Preliminary Report on Prevention of Tax Avoidance 6-8 (Comm. Print 1934). For a history of the personal holding company tax, see Libin, Personal Holding Companies and the Revenue Act of 1964, 63 Mich. L. Rev. 421, 421-429 (1965).
[ Footnote 4 ] Sections 561-565 also define the dividends-paid deduction used in the accumulated earnings tax, 26 U.S.C. 531-537 (1970 ed. and Supp. V).
[ Footnote 5 ] A personal holding company is defined as a corporation at least 60% of whose adjusted ordinary gross income is personal holding company income, and 50% of whose stock is owned by five or fewer persons. 26 U.S.C. 542 (a). Personal holding company income is income from passive investment property such as dividends, rents, or royalties. 543.
[ Footnote 6 ] Such dividends would, of course, be taxable to noncorporate shareholders at their fair market value. See 26 U.S.C. 301 (b) (1) (A).
[ Footnote 7 ] In Wetter, the Sixth Circuit, adopting a "plain meaning" rule, held [434 U.S. 528, 533] that the 1954 Code required the rule of 26 U.S.C. 301 to be used in establishing the value of the dividend deduction under the personal holding company tax. The meaning of the 1954 Code is, however, anything but plain.
[ Footnote 8 ] Although we have said that penalty tax provisions are to be strictly construed, see Ivan Allen Co. v. United States, 422 U.S. 617, 627 (1975); Commissioner v. Acker, 361 U.S. 87, 91 (1959), this rule of construction does not apply to the personal holding company tax since any penalty can be easily avoided by following - as petitioners' predecessor did - the guidelines set out in 26 U.S.C. 547.
[ Footnote 9 ] Petitioners also argue that the valuation standard provided by 301 was expressly adopted by the House as the standard to be used in establishing the value of a dividend with respect to a corporation as well as to a distributee-shareholder. In H. R. 8300, 83d Cong., 2d Sess. (1954), the [434 U.S. 528, 535] forerunner of the Internal Revenue Code of 1954, 562 (a) referred to 312 which stated: "The term `dividend' when used in this subtitle means a distribution (as determined in section 301 (a)) . . . ." (Emphasis added.) Section 301 (a) defined a "distribution" as "the amount of money . . . and the fair market value of securities and property received" by a distributee. This, petitioners conclude, shows that Congress meant to use the standard of 301, now codified as 26 U.S.C. 301, as the standard for valuing distributions of property with respect to both the distributing corporation and the distributee-shareholder.
The language in 312 italicized above was deleted by the Senate, however, and does not appear in 316 of the 1954 Code - which corresponds to 312 of H. R. 8300, supra. Moreover, as explained infra, at 536-538, the House Report states that the rule of 27 (c) of the Revenue Act of 1936, 49 Stat. 1665, was incorporated in the 1954 Code. If that is indeed the case, then 301 cannot be the section that governed valuation of property dividends under 562 (a) of H. R. 8300, since 301 does not embody the valuation rule of 27 (c) with respect to distributions to noncorporate shareholders. Instead, H. R. 8300, 301 (a), mandates the use of fair market value without regard to basis when the distributee is a noncorporate shareholder, whereas 27 (c) mandated the use of the lower of basis or fair market value. The rule of 27 (c) is used in H. R. 8300 only with respect to corporate distributes, taxpayers who were not the target of the personal holding company tax. There is, therefore, no unambiguous inference to be drawn from the linkage between 301, 312, and 562 of the House bill. See also nn. 13-14, infra.
Finally, petitioners argue that our decision in Ivan Allen Co. v. United States, supra, supports their contention that fair market value must be the measure of property dividends. But this is not the case. As we made abundantly clear in Ivan Allen, the fair market value of liquid assets figures only in calculating whether "earnings and profits . . . [have been] permitted to accumulate beyond the reasonable needs of the business." 26 U.S.C. 533 (a). Unrealized appreciation does not figure in the tax base to which the accumulated earnings tax applies. See 422 U.S., at 627 , 633. Since Ivan Allen thus holds that appreciation does not figure in the accumulated earnings tax base, there is no justification for reasoning from that opinion that such appreciation must nonetheless figure in the dividends to be subtracted from that base.
[ Footnote 10 ] See generally Drake, Distributions in Kind and the Dividends Paid Deduction - Conflict in the Circuits, 1977 B. Y. U. L. Rev. 45.
[ Footnote 11 ] Section 27 was added as part of a general revision of the undistributed profits and accumulated earnings taxes. See S. Rep. No. 2156, 74th Cong., 2d Sess., 12-13, 16-18 (1936). There is no discussion in the legislative history of the 1936 Act of the reason for applying 27 to personal holding companies.
[ Footnote 12 ] 49 Stat. 1732.
[ Footnote 13 ] The Court of Appeals theorized that this discrepancy may have been due to a typographical error in the Senate Report. As the bill which was to become the 1954 Code was passed by the House, the provisions of 316 of the Code were set out as 312. The Senate renumbered the bill, but adopted the discussion of the House Report essentially verbatim, [434 U.S. 528, 538] possibly failing to correct all instances where section numbers had changed. See 545 F.2d, at 270 n. 2.
[ Footnote 14 ] If one assumes that S. Rep. No. 1622, 83d Cong., 2d Sess. (1954), is correct in stating that Congress re-enacted 27 (c) of the Revenue Act of 1936 as 312 of the 1954 Code, 26 U.S.C. 312, but see n. 13, supra, then Treas. Reg. 1.562-1 (a), 26 CFR 1.562-1 (a) (1977), must be upheld because 312 (a) (3) provides a dividend valuation rule identical to that of 27 (c). But 312 is on its face addressed only to the narrow issue of the effect of dividends on corporate earnings and profits, an issue unrelated to the personal holding company tax. Therefore 312 is no more likely to be the correct locus of the re-enactment of 27 (c) than 301 of the Code. Moreover, even if the Senate did intend 312 to be the locus of the rule of 27 (c), ambiguity remains because the House, if it put 27 (c) anywhere, put it in 301 and 316 of the Code. See n. 9, supra.
[ Footnote 15 ] Treas. Reg. 1.562-1 (a), 26 CFR 1.562-1 (a) (1977), does not, of course, correspond to 27 (c) of the Revenue Act of 1936 in valuing depreciated property. The Treasury Regulation requires adjusted basis to be used in valuing all distributions of property; 27 (c) provided that the [434 U.S. 528, 540] lower of adjusted basis or fair market value would be used. See supra, at 536. However, we have no occasion to pass on the validity of 1.562-1 (a) as applied to depreciated property since, even if it should be invalid in that circumstance, this would not help petitioners in this case.
MR. JUSTICE STEVENS, concurring in the judgment and concurring in part.
The only portion of the Court's opinion which I am unable to join is that quoted by MR. JUSTICE POWELL in dissent. I do not see the ineluctable logical need to equate the amount of income received by the shareholder distributee with the amount of the deduction allowed the corporate distributor. In my judgment market value is the appropriate measure of the recipient's income, and adjusted basis is the appropriate debit on the corporation's books.
MR. JUSTICE POWELL, dissenting.
The Court's opinion, with commendable candor, recognizes that logic supports petitioners' position:
It is virtually conceded that this result cannot be squared with the acknowledged purpose of the personal holding company tax. Where statutory ambiguity exists without clarification in the legislative history, a court should read the statute to accord with its manifest purpose. A regulation that defies logic, as well as the statutory purpose, merits little weight.
I find no answer in the Court's opinion to the arguments advanced by Professor Drake. See Drake, Distributions in Kind and Dividends Paid Deduction - Conflict in the Circuits, 1977 B. Y. U. L. Rev. 45. See also H. Wetter Mfg. Co. v. United States, 458 F.2d 1033 (CA6 1972). *
I respectfully dissent.
[ Footnote * ] I do not view this as a case that, under the Court's holding today, the Government "wins" and personal holding company taxpayers (other than petitioners) "lose." It is not at all clear to me that the Court's resolution of the statutory ambiguity will in the end increase the Government's [434 U.S. 528, 541] "take." The personal holding company device is used by a limited number of sophisticated taxpayers. Under the "adjusted basis" rule upheld by this decision, many of them will be able to schedule the distribution of appreciated and depreciated property in an advantageous manner. Cf. General Securities Co. v. Commissioner, 42 B. T. A. 754 (1940), aff'd, 123 F.2d 192 (CA10 1941). I simply would have preferred a resolution that advanced the symmetry of the relevant Code provisions, see, e. g., 26 U.S.C. 301, 311, and one compatible with the plain purpose of the personal holding company tax. [434 U.S. 528, 541]