Beofre GOODRICH and HASTIE, Circuit Judges, and McILVAINE, District Judge.
This appeal by a taxpayer from a decision of the Tax Court, Irwin G. Lukens, 1956, 26 T.C. 900, challenges that court's conclusion that an amount paid by a corporation to a stockholder for the redemption of certain stock was essentially equivalent to and, under Section 115(g) of the Internal Revenue Code of 1939, 53 Stat. 48,*fn1 should be treated as a distribution of a taxable dividend to the stockholder.
The present problem has arisen in this way. A corporation, Florex Gardens, was organized in 1907 to engage in the business of growing and marketing flowers. Its entire capital stock, duly issued and fully paid for, consisted of 2000 shares of par value of $50 each. The taxpayer, Irwin Lukens, one of the several investors in the venture bought his stock at par and for cash. Later, the enterprise became a family corporation with taxpayer, his son George and his daughter Clara the sole stockholders.
Beginning in 1922 and thereafter, the son George devoted full time to Florex. He was in active charge of its management from about 1930. Taxpayer's principal occupation was banking, he being the president of a bank and a principal officer of a building and loan association. During the middle 1940's taxpayer, then more than 75 years old, was not active in the management or supervision of Florex. He visited the business premises only about five times annually. However, he was both president and a director of the corporation. George and Clara were the other directors. George often sought the advice of his father and at times deferred to him on important policy questions. This situation continued until 1950 when the taxpayer entirely severed his connection with the business.
The Tax Court also found that from 1946 to 1950 the taxpayer followed a course of action intended to culminate, as in fact it did, in his total withdrawal from the business and the giving of his remaining interest in the corporation to his son and daughter. The significant acts in the accomplishment of this design, as listed by the Tax Court, were gifts of stock to Clara and George in 1946, the redemption of stock in 1948 out of which the present controversy has grown, and final gifts of his remaining holdings in 1950.
At the time of the questioned redemption, the taxpayer owned 547 shares, George owned 526 and Clara owned 427, in all 1500 shares. The remaining 500 shares of the original issue had been redeemed and retired years earlier. The taxpayer's 547 shares were part of his original holding which he had bought for cash at par.
Over the years taxpayer had from time to time borrowed money from the corporation and repaid such loans. He also had loaned money to the corporation from time to time.As a result of these transactions he owed the corporation $30,000 in 1948.
In these circumstances and at the taxpayer's suggestion, it was agreed by the directors in 1948, taxpayer not voting, that the corporation would redeem 446 shares of taxpayer's stock at par and apply the proceeds, $22,300 against his indebtedness to it. The book value of the stock exceeded $50 per share at this time, although testimony was to the effect that the directors regarded $50 per share as a fair price. In this connection, although the operations of the corporation had been profitable in earlier years so that a surplus had been accumulated, it was losing money during 1948 and continued to do so for several years thereafter.
Finally, taxpayer's gift of his remaining stock to his son and daughter in 1950 was accompanied by his resignation as president and director and complete termination of his legal interest in the corporation and actual participation in its affairs.
On these facts the Tax Court ruled that the $22,300 realized by taxpayer on the 1948 stock redemption was taxable to him as a dividend distribution under Section 115(g).
This court has recently pointed out that in these Section 115(g) cases a reviewing court's function is twofold: to judge whether "the determination was made upon the application of correct criteria", and then to ascertain whether the evidence, evaluated in its proper legal frame of reference, is appropriate and adequate to support the determination.Ferro v. Commissioner of Internal Revenue, 3 Cir., 1957, 242 F.2d 838, 840.
In generality, the controlling criteria and legal conceptions are not troublesome. Characteristically, a dividend is a proportionate distribution to stockholders out of earnings and profits which leaves legal ownership and control of a corporation unchanged, while a bona fide and normal redemption of stock eliminates the interest represented by that stock with a proportionate increase of the ownership rights represented by the stock which remains outstanding. In rational conception, a stock redemption can properly be treated as "essentially equivalent" to a dividend distribution only if it exhibits or is attended by significant consequences which cause it, in net effect, to resemble a dividend distribution. See e.g. Ferro v. Commissioner, 3 Cir., 1957, 242 F.2d 838; Boyle v. Commissioner, 3 Cir., 1951, 187 F.2d 557, certiorari denied 342 U.S. 817, 72 S. Ct. 31, 96 L. Ed. 618; Smith v. United States, 3 Cir., 1941, 121 F.2d 692; Flanagan v. Helvering, 1940, 73 App.D.C. 46, 116 F.2d 937, 939-940; Hirsch v. Commissioner, 9 Cir., 1941, 124 F.2d 24; Smith v. United States, 1955, 130 F.Supp. 586, 591, 131 Ct.Cl. 748; cf. Commissioner of Internal Revenue v. Estate of Bedford, 1945, 325 U.S. 283, 65 S. Ct. 1157, 89 L. Ed. 1611; Earle v. Woodlaw, 9 Cir., 1957, 245 F.2d 119, certiorari denied, 354 U.S. 942, 77 S. Ct. 1400. Conversely, if the net effect of what is done is no different from a routine sale of corporate stock, the dividend analogy must fail and Section 115(g) cannot apply. Indeed, if no more or less has been accomplished than results from the normal outright repurchase of capital stock, factors which may be significant in doubtful situations exhibiting ambiguous actions, cannot reasonably be used to justify an artificial analogy to dividend distribution.
Perhaps the clearest example of this is a redemption of stock constituting an individual's entire holding which leaves him with no ownership rights whatever in the corporation. In other situations the fact that earnings are used to pay for a stock redemption,*fn2 or that the corporation is a family business, or that the individual rather than the corporation initially sought the redemption,*fn3 or any of sevt of the transaction. But where the fundamental fact appears that the stockholder is surrendering his entire interest, it is a contradiction of terms to characterize the transaction as a dividend, which presupposes persisting ownership rights. "Section 115(g) applies to one who has received a distribution on a stock interest which he continues to ...