Posted on January 9, 2008 at 6:55 pm by Admin
Like the briefs, the oral argument focused on whether Boulwareâ€™s diversion of funds was a distribution â€œwith respect to stock.â€ Boulware argued that the Ninth Circuit applied a contemporaneous intent requirement and did not look at whether the distribution was with respect to stock. No justice appeared to support the Ninth Circuitâ€™s view; by contrast, several repudiated that circuitâ€™s contemporaneous intent requirement to the extent that it did not conform to the â€œwith respect to stockâ€ requirement.
The government proposed a three-part test to determine whether a distribution is a return on capital: (1) the distribution must be with respect to stock; (2) the corporation must lack any earnings or profits; and (3) the distribution must not exceed the shareholderâ€™s basis in the stock.
Justice Ginsburg clarified that the term â€œwith respect to stockâ€ simply meant that there was no expectation that the corporation would receive consideration in return for the payment â€“ e.g., the cancellation of debt or employee services. The government acknowledged that this was â€œhalf the understandingâ€ of this phrase, but it emphasized that the other half of the understanding refers to â€œfunds you receive solely because of your status as a shareholder.â€ Addressing this idea later, Boulware contended that the distribution was indeed â€œwith respect to stockâ€ because it was made solely due to Boulwareâ€™s status as a controlling shareholder and not as a repayment of a loan or payment for services rendered. Boulware noted that to his knowledge, in every other case the government had taken the position that informal diversions to controlling shareholders were â€œwith respect to stock,â€ because the corporations involved had profits that the government intended to tax at both the corporate and individual levels, and the alternative position would allow a corporate deduction for stolen funds.
Justice Breyer introduced a hypothetical in which a corporation distributes money to its shareholders believing it will make a substantial profit. However, at the end of the tax year, it actually loses money. Justice Breyer pointed out that under the Ninth Circuitâ€™s test these distributions would not qualify as return of capital because they were intended as dividends rather than a return on capital. Because the â€œcontemporaneous intentâ€ test, Justice Breyer emphasized, would fail to classify such distributions as return of capital, it must be rejected. The government conceded that such a distribution would be a return on capital as long as an adequate basis existed.
After several justices seemed to have rejected the â€œcontemporaneous intentâ€ requirement, the Court next turned to whether the Ninth Circuitâ€™s error was harmless. Although the government argued that Boulware never asserted a â€œreturn of capitalâ€ defense, Boulware countered that the combination of the application of the â€œcontemporaneous intentâ€ requirement and the trial courtâ€™s rejection of a return of capital defense on a motion in limine meant that he had simply not been afforded the opportunity to put forward the defense. Boulware further argued that several pieces of evidence on the record indicate that he would have made this defense had the trial court applied the correct test.