United States v. Donruss Company

PETITIONER:United States
RESPONDENT:Donruss Company
LOCATION:Surface Transportation Board at the United States Department of Transportation

DOCKET NO.: 17
DECIDED BY: Warren Court (1967-1969)
LOWER COURT: United States Court of Appeals for the Sixth Circuit

CITATION: 393 US 297 (1969)
ARGUED: Oct 22, 1968 / Oct 23, 1968
DECIDED: Jan 13, 1969

Facts of the case

Question

  • Oral Argument – October 23, 1968
  • Audio Transcription for Oral Argument – October 23, 1968 in United States v. Donruss Company

    Audio Transcription for Oral Argument – October 22, 1968 in United States v. Donruss Company

    Earl Warren:

    Number 17, the United States, petitioner versus the Donruss Company.

    Mr. Rogovin.

    Mitchell Rogovin:

    Mr. Chief Justice and may it please the Court.

    This is an income tax case dealing with the construction or portion of the accumulated earnings tax.

    The purpose of this tax, the accumulated earnings tax, which has been a part of our tax fabrics since 1913, is to deter shareholders of a corporation from avoiding individual income tax by having the corporation accumulate earnings beyond the reasonable needs of the corporation.

    The Government’s petition for a writ of certiorari to review the judgment of the Sixth Circuit in this case takes place because the Sixth Circuit’s decision was in conflict with four other circuits, circuits that are in support of the United States in its construction.

    The surplus earnings tax deals with Sections 531 through 537 of the Internal Revenue Code and they have three essential features.

    Section 532 (a) of the Code has the critical operative provision in the context of the accumulated earnings tax.

    This is the provision that imposes the special tax on “every corporation formed or availed of for the purpose of avoiding the income tax with respect to its shareholders by permitting earnings and profits to accumulate instead of being divided or distributed.”

    This feature requires a particular showing of conduct and a particular showing of a state of mind.

    Questions of intent and state of mind however are difficult and since 1913, the statute has carried with it a rebuttable presumption regarding the prohibited purpose.

    Section 533 (a) of the Code carries the prohibited — carries this presumption.

    It provides that the fact that earnings and profits are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the income tax with respect to shareholders unless the corporation by the preponderance of the evidence shall prove to the contrary.

    Finally, since 1954, there has been a credit provision within the accumulated earnings tax and this is found at 535 (c), the most significant of the two credits, the 535 (c) (1) credit which in essence permits a credit notwithstanding the presence of this proscribed purpose.

    As to that portion of the accumulated earnings that if determined by the trier of fact to be reasonable, although the ultimate issue is whether or not there’s a proscribed purpose, whether or not it exists, even if it’s found to exist, the credit under 535 (c) (1) would wash out the tax at least as to that portion of the accumulation —

    Byron R. White:

    Is this true Mr. Rogovin even though you’re not relying on the presumption?

    Let’s assume there’s some expressed approval of what the purpose was.

    Mitchell Rogovin:

    Yes, sir.

    Byron R. White:

    And that is was to avoid income taxes.

    Mitchell Rogovin:

    Yes, sir.

    Byron R. White:

    Then as long as the accumulation is reasonable, there’s no penalty imposed.

    Mitchell Rogovin:

    Yes, Mr. Justice White, what had happened prior to 1954 was that if there are any portion of the total accumulation were determined to be unreasonable, then the tax would apply to the totality of the accumulation.

    The credit in 1954 allowed the taxpayer to at least take out of the ambit of a tax that portion which was determined to be reasonable at all times assuming that the avoidance purpose existed.

    Byron R. White:

    So this in effect that this law unreasonable (Inaudible)?

    Mitchell Rogovin:

    Pardon me sir.

    Byron R. White:

    This is just denounced to a law against unreasonable purpose in accumulation?

    Mitchell Rogovin:

    With the requisite of intent.

    The intent is built into the statute, the central feature.

    Byron R. White:

    Suppose the intent still maintain — still accumulate (Inaudible)?

    Mitchell Rogovin:

    As the net result of the ’54 credit.

    Mitchell Rogovin:

    To summarize, the special tax will imposed if the purpose of avoiding the shareholder tax is found to exists either because of the presumption in 533 (a) or if it’s found independently of it but subject to the credit for so much of the retained earnings as reasonably needed for the business.

    Now, the present case takes the form of a suit for refund.

    At the trial, the jury heard that evidence that for the years 1960 and 1961, the respondent, a bubblegum manufacturer had increased the accumulated earnings in those years in suit from approximately 1,638,000 to 1,679,000.

    There was no record of any dividends ever being paid in the years in suit or any indication of dividends having been paid since the inception of a corporation on 1947.

    The sole stockholder testified that the reasons for the accumulations were to purchase the stock of respondent’s major distributor.

    There was also a testimony that the accumulations were because of a fear of depression, possible fear of war and also a desire on the part of the respondent to follow by expansion the footsteps of the Wrigley Company.

    Now, in response to interrogatories, the jury found: one, that during the years in suit, the respondent had accumulated its earnings beyond the reasonable or reasonably anticipated needs of a business but that it had not retained its earnings for the purpose of avoiding the income on its sole shareholder.

    The Government’s appeal was based on the District Court’s refusal to define the phrase “the purpose” as it relates to the reason for the retention of the earnings.

    The Court of Appeals reversed and remanded the case for a new trial holding that the jury might well have been led to believe that tax avoidance must be the sole purpose behind an accumulation.

    Now, this position, the tax avoidance must be the sole purpose and not been asserted by either of the parties.

    The Sixth Circuit in reaching this decision rejected the Government’s position, the Government’s request for a jury instruction that tax avoidance need only be one of the purposes for the company’s accumulation policy and the Sixth Circuit went on to hold that the jury should be instructed that the accumulated earnings tax applies only if tax avoidance was the dominant, controlling or impelling motive.

    The Government seeks to review in this Court because we believe that this dominant purpose standard is erroneous.

    We believe that the proper view was the view that was requested of the District Court, that tax avoidance need only be one of the purposes of an accumulation for the special tax to come into play.

    The basic purpose of Sections 531 through 537 is to discourage the use of a corporation as a repository for accumulations.

    Accumulations which if distributed would have been taxed at the progressive rates upon the individual shareholders since corporations have a legal existence apart from that of the individual taxpayers and shareholders, the corporation can be interposed between the source of income and the receipt by the individual owner, thus allowing the beneficial owner to avoid the personal income tax, the tax of graduated rates.

    This avoidance device has been recognized by Congress since the inception of the modern income tax in 1913 and Sections 531 through 537 are an effort, a statutory effort to overcome the fact that we do not have integration between the income tax and the corporate tax.

    The purpose of the accumulated earnings tax is as this Court had concluded in Helvering v. Stock Yards, 318 U.S. 693 at page 979, “to compel the company to distribute any profits not needed for the conduct of its business so that when so distributed, individual shareholders will become liable.”

    Underlying this — underlying the statute is a legislative assumption that it becomes a misuse of a corporation if its profits are retained for the purpose of avoiding the stockholder’s individual income tax.

    Judge Learned Hand in United Business Corp. 62 F.2d 754 at 756 said as to the accumulated earnings tax, “Companies may accumulate what profits they please so long as they do not defeat the fiscal policies of the United States.

    Their business does not include the manipulation of dividends to avoid taxes by definition that has nothing to do with the normal management of their affairs.”

    Now, the critical language in this provision is the language in 532 availed of for the purpose of avoiding the income tax.

    And in no way does this language import any qualification such as formulated by the Sixth Circuit that this tax avoidance must be the dominant purpose among many purposes.

    Availed of simply means used to the extent tax avoidance induces or aids in inducing in the retention of accumulated earnings.

    The corporation has been used or in the statutory language “availed of” for this prohibited purpose.

    Now, the Government’s position is derived from the plain statutory language that implies no further qualification and also from this Court’s interpretation of that statutory language in the Stock Yards case.

    We thought as did four circuits that this issue had been made to rest.

    And the Stock Yards case, the First Circuit, the taxpayer argued that the accumulation policy of the corporation was intended to satisfy the debts of a New Jersey subsidiary upon its contemplated liquidation in 1940.

    Now, this plan had been inaugurated prior to the adoption of the Sixteenth Amendment and consistently followed by the corporation thereafter, so that argued the taxpayer, the corporation could not have been availed of for the proscribed purpose that out in the law.

    And this was their position as a matter of law.

    Now, although the First Circuit reversed the Board of Tax Appeals which had upheld the assertion of the accumulated tax.

    Mitchell Rogovin:

    The First Circuit rejected the taxpayer’s argument.

    The First Circuit in Chicago Stock Yards at 129 F.2d.937 at page 948 said, “It is clear that Section 104 would apply if in the totality of reason which induced the continuing of the accumulation, the forbidden motive of surtax avoidance played a substantial part.”

    The First Circuit thus rejected the concept of a dominant purpose theory.

    It was in this context that the case came to this Court and this Court stated at page 699, “A corporate practice adopted for the mere convenience above or for other reasons and without tax significance when adopted may have been continued with the additional motive of avoiding surtax on the sharehold — stockholders.

    The Board’s conclusion, that is the conclusion of the Board of Tax Appeals that the accumulated earnings tax was to impose, may justifiably have been reached in the view that whatever the motive when the practice of accumulation was adopted, the purpose of avoiding surtax induced or aided in inducing, the continuance of the practice.”

    Hugo L. Black:

    What case was that?

    Mitchell Rogovin:

    This is in the Stock Yards case Mr. Justice Black, 318 U.S. at page 699.

    Abe Fortas:

    Mr. Rogovin, I suppose it’s true that most companies now in for many years have most very large companies paid out only a small fraction of their earnings, isn’t that true as dividends?

    Mitchell Rogovin:

    I believe that’s correct sir.

    Abe Fortas:

    Now, is it — does the bureau proceed on the assumption that some of the largest companies are totally without the purpose of tax avoidance for the stockholders and that process of accumulation take anyone of them you like as an illustration, any of the largest companies.

    Take anyone of them that you like and can the bureau and does the bureau assume that the rule you advocate would or would not compel you to go after them.

    Mitchell Rogovin:

    Well, it’s two-part test.

    The objective part of the test has not been considered in your hypothetical and that is — are the accumulations unreasonable or the funds retained for the purpose of avoiding the surtax on individuals?

    Abe Fortas:

    I understand that part of it.

    I understand that problem I think.

    But some of them might be big, aren’t they?

    Mitchell Rogovin:

    I believe the track record of the revenue service in this regard tends to indicate that they are looking at a small, closely held corporation.

    Abe Fortas:

    That one — that’s exactly.

    That what bothers me and is — as I understand it the statutory provision has been used almost exclusively with respect to the small closely held corporations and what my question to you is whether the standard for you to contend would have an impact upon that or whether it would — whether it’s the bureau’s view that the standard is correct and you have a problem presented by the large corporations.

    Mitchell Rogovin:

    The concern of the Congress in passing the accumulated earnings tax was a concern that the stockholders could so manipulate the corporation and thereby require or cause the corporation to retain earnings, earnings that would not be passed on to the stockholders.

    Abe Fortas:

    I don’t think you’re contending that that should be the — a condition precedent to the bureau’s bulletin to invoke this section, are you?

    Mitchell Rogovin:

    Well, that’s a presumption that the Congress indulged in, in assuming that there’s close relation between stockholders and corporation could cause this result and that there would be no objective evidence to demonstrate tax avoidance and so the presumption was built into the statute.

    Abe Fortas:

    Are you telling this Court that the bureau construes this statute, these sections on unreasonable accumulations as applicable only to the small closely held corporation?

    Mitchell Rogovin:

    No theoretically, it could be applicable to a large listed corporation, if the listed corporation Mr. Justice Fortas at the liquid assets and the accumulated cash in an unreasonable posture for the states —

    Abe Fortas:

    Was it ever been applied to any company other than a small closely held company?

    Mitchell Rogovin:

    I believe that it had been applied in one case.

    Potter Stewart:

    Trico.

    Mitchell Rogovin:

    Trico to a 1500 stockholders.

    Abe Fortas:

    That’s the largest.

    Mitchell Rogovin:

    That’s about the largest, yes sir.

    Abe Fortas:

    I know the — I believe the origin of these provisions way back under Section 102 I think were the Christiana Corporation and those closely held companies but certainly the wording of the statute is much broader and certainly the rule for which you are now contending would literally and in any event open up the question of the large corporations that are held generally, isn’t that right?

    Mitchell Rogovin:

    Technically it would open it up to — technically we have construed — we were construing it as it has always been construed.

    To respond to your question, however, I feel the question of the nature of the accumulation would differ substantially than the large corporation.

    Abe Fortas:

    Well, what you’re saying isn’t that a large corporation might or it might not be able to show some intended or prospective need for the accumulation great enough and immanent enough to justify their holding onto without the accumulation being characterized as unreasonable.

    Mitchell Rogovin:

    I believe the pressures of large listed corporations, the stockholder pressures are such that large amounts of liquid assets not being applied for the purposes of the corporation would generate better management if not dividends.

    Abe Fortas:

    Well, that’s debatable.

    Earl Warren:

    I wonder why if Congress intended this to apply mainly to small closely held corporations, it wouldn’t have said so in the Act.

    Certainly, this must have been a matter of general concern to large companies as well as small companies when Congress was using the general language that it used.

    Why wouldn’t it make the distinction in the statute rather than to have you make it in the administration of the statute?

    Mitchell Rogovin:

    I have no answer to that question Mr. Chief Justice.

    I believe that clearly, the —

    Earl Warren:

    Well, let’s put it this way, put it this way.

    If Congress wrote the statute generally, what authority is there in the Internal Revenue Bureau to interpret it in this manner just as against these small corporations that are closely held and not against the — not against the big corporations?

    Abe Fortas:

    Because the concern of the Congress was in the retention for the benefit of shareholders and in the large corporations, listed corporations with hundreds of thousands of shareholders, that potential just doesn’t exist as any degree of frequency.

    Mitchell Rogovin:

    It does exist and that’s what Congress was concerned about in the main and has been expressed this concern throughout the reenactments of the statutes since 1913 but there has been no indication that the statute would not apply to a large corporation if the factual pattern so existed.

    I don’t think the revenue service is binding itself that it would not go order a large corporation and raise this issue if it existed.

    But the facts just don’t support it in the large corporations.

    Byron R. White:

    Your ability to make it stick would be able to — would depend on your ability to prove that the accumulation was unreasonable, would it not?

    Mitchell Rogovin:

    Yes sir, that’s correct.

    Byron R. White:

    And I assume that the service would move against any corporation that it had what it thought objectively was an unreasonable accumulation.

    Mitchell Rogovin:

    Right.

    Abe Fortas:

    But why in this particular case for example isn’t the suggestion that the accumulated on list because they were thinking about going out in the market and buying the stock of a company that owned what was a substantial block if they were going out the market and buy some of the stock of a related company?

    Mitchell Rogovin:

    The distributor, yes.

    Abe Fortas:

    They have never done it.

    Well, as I remember the facts of this case.

    But nevertheless they said that they were fixed and we’re thinking about getting bigger stock acquisition.

    Why didn’t that put them in the category of a big company rather than a small company for purposes of the application so to speak of this statute?

    Mitchell Rogovin:

    This was a solely owned corporation, wholly owned by one individual.

    The testimony was given as to why the accumulations were being retained and the jury evidently didn’t feel satisfied because they found for the Government, they found that they were unreasonable accumulations.

    We’re talking about accumulations that come about because of loans to relatives, accumulations that come about because of large portfolios of stock that have no relationship to the corporation.

    Mitchell Rogovin:

    These are not normally the situation that you find with a large listed corporation and —

    Hugo L. Black:

    When was this law passed?

    Mitchell Rogovin:

    1913.

    Byron R. White:

    Excuse me.

    Just to help me a little bit.

    Is the issue here really whether the Government was proved the purpose or only one of several purposes?

    Is that the real issue here?

    Mitchell Rogovin:

    That’s — those are the words but it’s the taxpayers’ burden.

    Byron R. White:

    The taxpayer but it seems to me if the taxpayer could prove that there was a reasonable purpose, he is off — he certainly doesn’t pay any tax, does he?

    Mitchell Rogovin:

    That the structure of the tax would reach that result.

    Byron R. White:

    So that — so that even if there was also the purpose of avoiding taxes, he would still win?

    Mitchell Rogovin:

    As long as the accumulation were reasonable, he would still win, that’s correct.

    Byron R. White:

    So, he doesn’t have to prove that it’s the — all he has to prove — he does avoid additional tax such by approving one other purpose besides avoiding.

    Mitchell Rogovin:

    Well, as to those accumulations, he may have a million dollar accumulation and the taxpayer may have 15 or 20 purposes ascribed to the accumulation and then the trier of fact would determine whether for example monies that were set aside for a fear of a depression, a reserve that was set up of that nature was a reasonable type of reserve, the Court may say no, that’s unreasonable.

    Byron R. White:

    They decide it’s unreasonable that they really decided that there is no other purpose other than to avoid tax.

    Mitchell Rogovin:

    Well, the Court could find that both that the accumulation were reasonable if and that concurrently throughout all of this, there was a tax avoidance motive.

    Byron R. White:

    And the taxpayer would win?

    Mitchell Rogovin:

    And the credit would allow that portion which is determined to be reasonable.

    But as to those portions that are not determined to be reasonable, those plans —

    Byron R. White:

    And there isn’t any other reason for it.

    Mitchell Rogovin:

    Well, it’s simply that the trier of fact determine that that wasn’t a reasonable.

    William J. Brennan, Jr.:

    Let’s see if I get you Mr. Rogovin.

    They showed $200,000.00 accumulation.

    The reasonable need to the business is concluded are $100,000.00.

    To that extent is the credit, is that what you just said?

    Mitchell Rogovin:

    There would be a $100,000.00.

    William J. Brennan, Jr.:

    Yes and the tax would be assessed on against the other $100,000.00 is that it?

    Mitchell Rogovin:

    That is correct.

    William J. Brennan, Jr.:

    Now suppose you had a case where in fact the accumulation is again $100,000.00, but you know that the only purpose of the accumulation was, well, not the only purpose but the primary purpose was tax avoidance.

    Yet they also introduced evidence that no they had a business need and a $100,000.00 is reasonable, again, the $100,000.00 be credited, wouldn’t it?

    Mitchell Rogovin:

    That’s correct.

    William J. Brennan, Jr.:

    And there will be no tax in that situation.

    Mitchell Rogovin:

    That’s correct and what the lower court — what the Sixth Circuit has done in this case is to set up an unintended element in the case, in the statute.

    They are saying that if a corporation with an admitted tax avoidance purpose that this corporation could avoid the penalty, if the trier of fact was persuaded that at least equal weight was to be given to the non-tax reasons ascribed by the corporation.

    Now, we believe this is an erroneous statement of the statute.

    If a corporation has a variety of motives for the accumulation, it doesn’t matter which motive predominates.

    Congress provided for the elimination of the tax through the credit to the extent that they’re demonstrable business needs to justify the accumulation and what the Sixth Circuit is doing is putting into the statute an extremely heavy burden.

    William J. Brennan, Jr.:

    Well, I don’t understand as to how that comes down to anything except as the hypothetical as I suggested to you.

    Except that if it’s established that in so far as the accumulation is related to the reasonable needs of the business, there’s no tax, any excess there’s a tax, is that right?

    Mitchell Rogovin:

    No, there has to be the finding under 532 finding that the purpose of the accumulation was to avoid the tax at the shareholder level.

    Now, there is a presumption —

    William J. Brennan, Jr.:

    I know but the presumption is not rebutted in the situation that you choose.

    If all you establish is that in so far as “X” dollars are concerned, that’s related to the reasonable needs of the business period then you pay a tax on the excess of that.

    Hugo L. Black:

    May I ask you, if a single stockholder of the corporation made any effort to prove that in the manufacture of bubblegum he needed more than a $1,700,000.00 profit in one year in order to carry on his business?

    Mitchell Rogovin:

    There was no evidence of that nature that the $1,678,000.00 was the accumulation over years.

    Hugo L. Black:

    Did he indicate that he wanted to enlarge the bubblegum business for that additional fund?

    Mitchell Rogovin:

    Well there were some indication if they wanted to follow on the footsteps of the Wrigley Company but there were definite plans as to what he was going to do with these funds.

    I might add that this —

    Hugo L. Black:

    As I recall it, the Roosevelt Administration at one time thought that this law was not enough to prevent tax evasion and attempted to get laws through which would coerce payments to the stockholders in order to make them liable for the tax, isn’t that right?

    Byron R. White:

    It not only attempted but it enacted many, many laws, the personal holding company law.

    It attempted and succeeded.

    Hugo L. Black:

    That is a great trouble in the court to go the good resentment against such a law.

    Mitchell Rogovin:

    Well, the Congress has uniformly reenacted the statute and the statute has the effect.

    The policy is to put a pressure on the corporation to divulge, to distribute dividends where they have no other use for the accumulated earnings to the extent that there is another purpose, a business purpose.

    Hugo L. Black:

    And that was strengthened during the Roosevelt Administration at one time, wasn’t it?

    Mitchell Rogovin:

    Yes, it was.

    Hugo L. Black:

    By the tax law which went further.

    Mitchell Rogovin:

    In 1938, the Senate Finance Committee had an opportunity to strengthen the presumption in the statute and the Finance Committee described the changes that took place as quote, this is in the page 17 of the brief, “requiring the taxpayer by a clear preponderance of the evidence to prove the absence of any purpose to avoid surtaxes upon shareholders after it has been determined that the earnings and profits had been unreasonably accumulated.

    We believe that the decision of the Sixth Circuit is erroneous that this decision of this Court in the Stock Yards case is controlling.

    Potter Stewart:

    Now, Mr. Rogovin, the Stock Yards case was a case in which the Board of Tax Appeals has found first of all that the corporation when they say was Prince in corporate clothes that involved a man by the name of Mr. Prince and then the Board of Tax Appeals further found that the sole purpose, the sole purpose of the retention of earnings was to avoid taxes.

    Potter Stewart:

    That have been the finding by the BTA in that case, hadn’t it?

    And the issue in this case once it finally got here was whether or not a corporation originally formed for another purpose could later be availed of, the retention of earnings for the prohibited purpose, that was the basic issue here then finally there was a question of accepting the fact finding of the BTA.

    Mitchell Rogovin:

    As to the language of this Court with respect to induces or aids and inducing, the purpose in question, this was the language that the Court inserted.

    The First Circuit had spoken of substantial, they referred to avoidance playing a substantial part and this Court ignored that language.

    Potter Stewart:

    The administrative body, the fact finding body had found that it was the sole purpose of Mr. Prince, of Mr. Prince’s corporation, had it not?

    Mitchell Rogovin:

    It had.

    Yes sir.

    Thank you.

    Earl Warren:

    Mr. Braunstein.

    Richard L. Braunstein:

    May it please the Court.

    The issue before this Court is the construction of the statute that’s been on the books for many, many years since 1913.

    The statute as enacted at that time provided that a corporation formed or fraudulently availed of for the purpose of preventing tax on the shareholders would trigger a penalty tax on the shareholder at that time.

    There was a rebuttable presumption then as there is now that if earnings were permitted to accumulate beyond the reasonable needs of the business that this was prima facie evidence for the purpose to escape the tax.

    The statute has been amended throughout the years, the word fraudulently was excised.

    The tax is now imposed on the corporation rather than the shareholders and instead of a prima facie evidence or rebuttable presumption, we have a virtual determinative assumption and once a corporation accumulates its earnings beyond its reasonable needs that unless the taxpayer can come forward and determinatively show otherwise that the penalty applies.

    Hugo L. Black:

    May I ask if you know why the Senate or Congress show why they struck out the word fraudulently?

    Richard L. Braunstein:

    I think there was the question that under common law, it was very difficult to establish fraud and that was the reason that was struck out.

    The reason that the tax was then imposed on the shareholder, it was first imposed on the shareholders then it was thought perhaps that it was first imposed on the corporate shareholder and then on a corporation, that was a constitutional question involved.

    But I think the purpose going into the statute that reading the early cases is that there are a lot of holding company cases involved here.

    At the time the statute was enacted, there was no corporate tax, taxpayers were permitted to deal with their corporation in situations which would lead to tax avoidance and what happened many taxpayers were able to, who had stocks and securities in receiving income on that were able to put it in a corporate shell and really isolate themselves, and insulate themselves from any taxes.

    In addition, the taxpayer was permitted to sell stock which he had purchased to his corporation and if you realize the laws on that, he could take it and I think if this came up, this case came up in 1913, we can make a very strong argument that the purpose required was the sole purpose and that the Court used the word formed fraudulently because it was talking about a situation where a corporation was used in a fraudulent manner, in a manner inconsistent as what we deemed to be the normal use of a corporation.

    And I think have this case come up, we could say that the case, the statute would only apply if there was absolutely no reason, no valid reason that the sole purpose for the shareholder of forming this corporation had to be tax avoidance.

    Byron R. White:

    Is that a valid reason?

    Richard L. Braunstein:

    The sole valid — well, that the sole purpose for the corporation, there was no business reason that before the penalty was to apply, the Court would have to find that the sole and only purpose of forming the corporation was —

    Byron R. White:

    But to succeed don’t you have to say that even — that the taxpayer may succeed even though the reason he has isn’t a very good reason and even though, even though he can’t prove that the accumulation is reasonable in terms of business need.

    Richard L. Braunstein:

    I think basically coming down to our test and what the Sixth Circuit has really assigned is that once it shown that the accumulation is beyond the objective reasonable needs of the business and that phrase has tremendous significance, that’s been determined as fixed, definite, certain plans.

    Almost balance sheet liabilities and written commitments.

    Now, once the taxpayer has accumulated beyond that, and the fact that he says, “Well, my purpose is really I’d like to expand.

    I’d like to acquire but I just can’t go out and buy a newspaper or a radio station or a cement plant.

    It’s just impossible.

    Richard L. Braunstein:

    I’m looking.”

    The position of the Government today is that you have — you’re out of the ball game and the reason they say that is they say what is the A purpose test?

    How do we determine that?

    Well, it’s very simple, they say if the shareholder is subject to taxable income, he’s in a tax bracket, he has no operating law as carryovers and he has been advised that a distribution would result in taxable income.

    Well, that’s all you have to show because then it follows that accumulating results in an avoidance of the tax which is true.

    Byron R. White:

    And if that avoidance is the purpose.

    Richard L. Braunstein:

    And the avoidance is the purpose.

    There’s — even though he might —

    Byron R. White:

    But this really isn’t a case about whether you need one or several purposes?

    Richard L. Braunstein:

    It isn’t.

    I think the Government concedes, he might have 100 purposes and that you might be talking about tax avoidance or the tax purpose might be incident, remote, he would not really care about it but the tax applies, that’s the Government’s position.

    They say, if it’s one out of 100 reasons, the tax applies.

    Basically, if you take that approach —

    Potter Stewart:

    The Government — the Government says that its position is that it’s up to the taxpayer to prove in complete absence of any tax avoidance purpose and your point is that that’s impossible to do.

    Richard L. Braunstein:

    It’s impossible, you can’t do it.

    The only two situations that I could think of is that if you have a net operating loss carryover, we can show the distribution —

    Potter Stewart:

    Would not result in any (Voice Overlap)?

    Richard L. Braunstein:

    — will not result in any income.

    Or in the other situation where someone has just completely and honestly ignorant and had not been advised but these are — it just doesn’t happen.

    And I think the whole point of the Government’s position is really not asking for a construction of the statute.

    I mean you can forget about availed of for purpose.

    What the Government’s position in effect of saying is that if you accumulate beyond fixed definite and reasonable needs; forget about it if you are a closely held corporation.

    And we think that at least that a small businessman should have the opportunity to try to rebut this presumption.

    Now, the Sixth Circuit isn’t giving anything here.

    I mean, when you talk about it, the burden, that’s the determinative burden which this taxpayer has to show that the tax avoidance was not the dominant or impelling motive.

    Well, he just can’t sit up there and say, “Well, that wasn’t my motive.”

    He’s got to be fairly specific and concrete in what he’s saying and I think that the thing that really disturbs us about this case is you’re really preventing expansion of the smaller corporation.

    I just can’t see how he could expand under the Government’s interpretation.

    Hugo L. Black:

    Suppose he hadn’t incorporated, could he expand?

    Richard L. Braunstein:

    I think he could sir, yes.

    Richard L. Braunstein:

    But he’d be at a tremendous disadvantage on the publicly held companies.

    I think you’ve got a reverse twist Justice.

    I think perhaps 1913, when this statute was enacted, the business was held and closely held family groups and they represented the substantial and economic power in this country.

    I think things have changed where the substantial economic powers in the publicly held corporations with a statute which was aimed at the power, the economic power is now being applied against the little men and the persons that it was intended to cover initially are just not being covered at this particular time.

    And I think basically, our position here is that simple that what the Government asked is not a construction of the statute.

    There is no construction, there is no statute and we think the only real tenable and reasonable view is the position of the Sixth Circuit.

    Earl Warren:

    We’ll recess now, Mr. —