SCOTUS Reports

Tag: Preferential Dividends

  • National Securities Series v. Commissioner, 13 T.C. 884 (1949): Dividends Paid on Stock Redemption and Surtax Credit

    13 T.C. 884 (1949)

    Distributions of net earnings by a regulated investment company upon the redemption of its shares are not considered preferential dividends and can be included as dividends paid when calculating the basic surtax credit.

    Summary

    National Securities Series, an open-end investment trust, redeemed shares and distributed net earnings to shareholders. It then included these distributions as dividends paid for its basic surtax credit. The Commissioner of Internal Revenue argued that these distributions were preferential dividends, disqualifying them for the surtax credit. The Tax Court held that the distributions were not preferential dividends because all shareholders had an equal opportunity to redeem their shares, and the method provided an intrinsically fair way of distributing earnings. Therefore, the company could include the distributions as dividends paid when calculating its basic surtax credit.

    Facts

    Each petitioner was a regulated investment company, holding property in trust and investing in securities. The petitioners regularly issued certificates representing shares in the trust property and redeemed these certificates under the provisions of their trust agreement. As open-end investment companies, shareholders could surrender their shares for redemption at any time, receiving a proportionate share of the assets, including net income received to the date of surrender. During the tax year, petitioners redeemed shares and paid surrendering shareholders their share of assets and net income. Petitioners treated these payments as dividends paid when computing their basic surtax credit.

    Procedural History

    The Commissioner of Internal Revenue determined that the distributions were preferential dividends and could not be treated as dividends paid for computing the basic surtax credit. The Tax Court, however, reversed its original stance based on the Second Circuit’s decision in New York Stocks, Inc. v. Commissioner, which addressed the same issue. The cases were consolidated for trial and opinion in the Tax Court.

    Issue(s)

    Whether earnings paid to shareholders upon the redemption of shares are preferential dividends under Section 27(h) of the Internal Revenue Code, thus not includible as dividends paid when computing the basic surtax credit under Sections 362(b) and 27(b)(1) of the Code.

    Holding

    No, because the distributions were made available in conformity with the rights of each stockholder, where no act of injustice to any stockholder was contemplated or perpetrated, where there was no suggestion of a tax avoidance scheme, and where each stockholder was treated with absolute impartiality, the distribution is not preferential within the meaning of the statute.

    Court’s Reasoning

    The court relied heavily on the Second Circuit’s decision in New York Stocks, Inc. v. Commissioner, which reversed the Tax Court’s prior ruling on the same issue. The Second Circuit held that distributions by an open-end trust to stockholders upon redemption of shares, representing earnings up to the date of redemption, were not preferential dividends under Section 27(h). The court emphasized that it was impossible to require the company to declare a complete dividend every time a share was redeemed. The court also cited a report from the House Committee on Ways and Means, stating that no distribution should be considered preferential if it treats shareholders with substantial impartiality and consistently with their stockholding interests. The court reasoned that each shareholder had an equal opportunity to redeem, and the method used provided an intrinsically fair distribution of earnings.

    Practical Implications

    This decision clarifies that regulated investment companies can include distributions made upon stock redemptions when calculating their basic surtax credit, provided that all shareholders have an equal opportunity to redeem their shares and the distributions are made without preference. This ruling is important for investment companies as it allows them to take full advantage of tax benefits intended by Congress. This case and the Second Circuit’s decision in New York Stocks, Inc. establish a precedent for treating distributions upon stock redemption as non-preferential, influencing how similar cases are analyzed and ensuring fair tax treatment for regulated investment companies and their shareholders. Later cases would distinguish situations where redemption opportunities were not equally available to all shareholders or were part of a tax avoidance scheme.

  • New York Stocks, Inc. v. Commissioner, 8 T.C. 322 (1947): Preferential Dividends and Surtax Credit for Mutual Investment Companies

    8 T.C. 322 (1947)

    Distributions by a mutual investment company upon redemption of its stock, which include a share of current net earnings, are considered preferential dividends and are not eligible for the basic surtax credit under Section 27(b)(1) of the Internal Revenue Code, due to restrictions imposed by Section 27(h).

    Summary

    New York Stocks, Inc., a mutual investment company, redeemed its stock at stockholders’ requests throughout the taxable year, paying the net asset value for the redeemed stock. The net asset value included a share of the company’s current net earnings up to the redemption date. The company claimed a surtax credit for these earnings paid out upon redemption in addition to a surtax credit for ordinary dividends. The Tax Court held that these distributions were preferential dividends under Section 27(h) of the Internal Revenue Code and, therefore, not includible in the amount of dividends paid for the basic surtax credit under Section 27(b)(1).

    Facts

    New York Stocks, Inc. was an open-end mutual investment company issuing multiple series of special stock. Proceeds from each series were invested in specific industry sectors. Stockholders had the option to redeem their shares at any time for the net asset value, less a small redemption charge. The net asset value included the stockholder’s proportionate share of the series’ net earnings up to the redemption date. During the tax year, the company redeemed shares for an aggregate sum of $5,717,989.76, which included $40,932.69 of net earnings up to the redemption date.

    Procedural History

    The Commissioner of Internal Revenue disallowed a portion of New York Stocks, Inc.’s claimed basic surtax credit. The Tax Court heard the case to determine whether the $40,932.69 in earnings distributed upon redemption of stock qualified for the basic surtax credit. The Tax Court ruled in favor of the Commissioner.

    Issue(s)

    Whether a mutual investment company is entitled to include the amount of its current net earnings distributed upon the redemption of stock in the amount of dividends paid for purposes of the basic surtax credit under Section 27(b)(1) of the Internal Revenue Code, given the restrictions imposed by Section 27(h) regarding preferential dividends.

    Holding

    No, because the distributions were deemed to be preferential dividends under Section 27(h) of the Internal Revenue Code. These distributions did not qualify for the basic surtax credit under Section 27(b)(1).

    Court’s Reasoning

    The court reasoned that while mutual investment companies could treat the distribution of earnings as taxable dividends to shareholders for purposes of meeting the 90% distribution requirement under Section 361(a)(4), this did not exempt them from the general restrictions of Section 27(h) regarding preferential dividends. The court relied on May Hosiery Mills, Inc., which established that distributions on the redemption of stock are preferential if there is no plan for redeeming all shares of a class or a proportionate amount from each stockholder on the same terms and during a definite period. The court found that because New York Stocks, Inc. redeemed shares only when stockholders chose to exercise their option, the distributions were preferential. The court stated, “The restriction in Section 27(h) against preferential dividends applies to distributions in liquidation on redemption of stock as well as to ordinary dividend distributions.” The court distinguished United Artists Theatre Circuit, Inc., where all preferred stock of a class was retired under a plan of recapitalization.

    Practical Implications

    This case clarifies that mutual investment companies must adhere to the preferential dividend restrictions when calculating the basic surtax credit, even if the distributed earnings qualify as taxable dividends for other purposes. It reinforces the principle that ad hoc redemptions of stock, based solely on stockholder option, are likely to be treated as preferential distributions. Legal practitioners advising mutual investment companies must ensure that redemption plans are structured to avoid preferential treatment to maintain eligibility for the basic surtax credit. Later cases have cited this ruling to support the disallowance of dividends-paid credits where distributions were not pro rata across all shareholders or classes of stock.