Corporation Argues Refund Improperly Denied for Dividend Deductions

1) For non-governmental corporate parties please list all parent corporations:

Appellant Conopco, Inc. is a wholly-owned subsidiary of Unilever United States, Inc., which is an indirect subsidiary of Unilever N.V. and Unilever PLC.

2) For non-governmental parties please list all publicly held companies that hold 10% or more of the party's stock:

Unilever N.V. and Unilever PLC own indirectly Unilever United States, Inc., which wholly-owns Conopco, Inc.

3) If there is a publicly held corporation which is not a party to the proceeding before this Court but which has a financial interest in the outcome of the proceeding, please identify all such parties and specify the nature of the financial interest or interests:

Please see above.

4) In all bankruptcy appeals counsel for the debtor or trustee of the bankruptcy estate must list: 1) the debtor, if not identified in the case caption; 2) the members of the creditors' committee or the top 20 unsecured creditors; and 3) any entity not named in the caption which is an active participant in the bankruptcy proceeding. If the debtor or trustee is not participating in the appeal, this information must be provided by appellant.

Not applicable.

March 4, 2008

Appellant established an employee stock ownership plan ("ESOP" or "plan"). Appellant paid a dividend to the plan pursuant to a redemption of stock held by the plan, and the plan distributed the cash proceeds to participants in the plan within 90 days after the close of the plan year. Appellant claimed a deduction under Section 404(k)(1) for applicable dividends. The District Court held that the deduction, though otherwise permissible under Section 404(k)(1), was disallowed by Section 162(k)(1), which disallows deductions that are otherwise allowable for amounts paid by a corporation "in connection with the reacquisition of its stock". (A0025 (July 17, 2007 Opinion ("Op.")).)

This holding of the District Court was erroneous and is directly contrary to decisions of the Ninth Circuit and the District of Minnesota, the only other courts that have considered the issue. On virtually identical facts, both of those courts concluded that Section 162(k)(1) does not disallow a corporation's deduction of applicable dividends under Section 404(k)(1), even though the initial distribution -- the dividend to the ESOP -- is pursuant to a redemption of corporation stock. Boise Cascade Corp. v. United States, 329 F.3d 751, 757-58 (9th Cir. 2003); General Mills, Inc. & Subsidiaries v. United States, No. 06-3547(DSD/SRN), 2008 WL 151626, at *2-*3 (D. Minn. Jan. 15, 2008). Because of this Court's longstanding policy favoring uniformity of decisions interpreting federal tax law, on this appeal the Court should follow the Ninth Circuit and the District of Minnesota unless both of those courts "clearly misconstrued the law". Comm'r v. Stockly, 221 F.2d 745, 748 (3d Cir. 1955). But they did not. Those courts correctly interpreted the law. The Court should therefore reverse the District Court.

The conclusion of the District Court was error because the Court treated the deduction claimed by Appellant as arising solely because of the dividend paid by Appellant to the ESOP. Based on that premise, and the fact that the dividend was pursuant to a redemption of stock, the Court concluded that the deduction was claimed for an amount paid in connection with the reacquisition of stock and therefore was disallowed under Section 162(k)(1).

But Appellant did not claim a deduction for the dividend paid by Appellant to the ESOP. The Code does not allow a deduction for such a dividend standing alone. Thus, whether the dividend paid by Appellant to the ESOP was "in connection with" the reacquisition of stock is irrelevant.

Instead, as permitted by Section 404(k)(1), Appellant claimed a deduction for an "applicable dividend" -- a dividend that is "paid to the plan and is distributed in cash to participants in the plan or their beneficiaries not later than 90 days after the close of the plan year in which paid". Section 404(k)(1), (k)(2)(A)(ii) (emphasis added). As the courts in Boise Cascade and General Mills recognized and the court below acknowledged, the distribution from the plan to the participant was not paid in connection with the redemption of stock. As a result, the "applicable dividend" was likewise not paid in connection with the reacquisition of stock, and therefore Section 162(k)(1) does not disallow its deduction.

Appellant created a trust (the "Trust") to implement the Plan. (A0092 (Stips. ¶ 8).) Pursuant to the Plan, in 1989 Appellant issued approximately 2.2 million shares of voting convertible preferred stock ("Preferred Stock"), which the Trust purchased. (A0005-06 (Op.); A0092 (Stips. ¶ 9.); A0215 (Bestfoods 10-K for fiscal year ending December 31, 1997).) During the period in question, the shares owned by the Trust represented approximately two to three percent of Appellant's voting stock. (A0006 (Op.); A0265-297 (ESOP Spreadsheets); A0500-517 (Distribution Spreadsheet for 1999); A0519-0533 (Distribution Spreadsheet for 2000); A0246, A0250, A0254, A0258, A0263 (Bestfoods 10-Qs for Mar. 31, 1999; June 30, 1999; Sept. 30, 1999; Mar. 31, 2000; June 30, 2000).)

Under the terms of the Plan, shares of Preferred Stock were allocated to participants' (employees') accounts. (A0006 (Op.); A0092-093 (Stips. ¶ 13); A0307 (CPC Savings/Retirement Plan); A0354, A0356 (Bestfoods Savings/Retirement Plan).) Upon an employee's termination of employment, the employee (or beneficiary) could elect to receive a cash payment from the Trust equal to the value of the shares of Preferred Stock allocated to the employee's account, or, alternatively, to receive Appellant's common stock that the Trust would receive upon its conversion of such Preferred Stock into common stock. (A0006 (Op.); A0093 (Stips. ¶ 17).)

In each of the tax years 1994-2000, some employees with vested account balances in the Trust terminated their employment with Appellant and elected to receive cash payments of their account balances. (A0006-007 (Op.); A0453-459, A0462-468, A0471-476, A0479-483, A0486-488, A0491-493, A0496-498 (Amended tax returns on Form 1120X for 1994-2000).) Appellant made payments in each of those years to the Trust in redemption of the Preferred Stock allocated to those employees' accounts. (A0007 (Op.).) Within 90 days after the close of the plan year in which the payments had been made to the Trust, the Trust made distributions to those employees. (A0009-010 (Op.).) In the tax years 1994-2000, Appellant redeemed shares of Preferred Stock worth a total of $47,753,608, and the Trust made distributions to employees in the same amount. (A0007 (Op.); A0096 (Stips. ¶¶ 39-45).) Appellant timely filed claims for refunds of $13,823,873 for claimed deductions of $47,753,608, each of which the Internal Revenue Service (the "Service") either denied or failed to grant, which has the same effect as denial. (A0007 (Op.); A0095 (Stips. ¶¶ 33, 37); A0082-083 (Solinga Declaration); Section 6532(a)(1).)

Appellant brought this action for a tax refund. The District Court denied Appellant's motion for summary judgment and granted Appellee's cross-motion for summary judgment. (A0005 (Op.).) The District Court agreed with Appellant that Section 404(k)(1) allows Appellant's claimed deductions. (A0009, A0019 (Op.).) However, it also held that Section 162(k)(1) disallows the deductions. (A0027 (Op.).) Despite the fact that Section 404(k)(1) allows deduction only of "applicable dividends", in the District Court's view Appellant sought deduction of "distributions it made in redemption of stock" -- that is, payments made by Appellant to the Trust. (A0005 (Op.).) Therefore, in applying Section 162(k)(1), the District Court formulated the question as "whether Conopco's redemption proceed distributions to redeem its Preferred Stock from the ESOP Trust were 'amount[s] paid or incurred by a corporation in connection with the reacquisition of its stock'". (A0025 (Op.) (quoting Section 162(k)).) The Court concluded that the payments to the Trust were "in connection with" the reacquisition of stock, and held that as a result Section 162(k)(1) disallowed Appellant's deductions. (A0025 (Op.).) The District Court did not reach Appellee's alternative arguments: that the deductions should be disallowed under the "double deduction" doctrine and that the Secretary of the Treasury had determined under Section 404(k)(5)(A) that the deductions represented an evasion of taxation. (A0027 (Op.).)

As the District Court recognized, the plan's distribution of cash was not in connection with the redemption of stock. Therefore, an action that is necessary for the deduction (the distribution of cash to participants) was not done in connection with the redemption of stock. Thus, Section 162(k)(1), which disallows the deduction of amounts paid in connection with the redemption of the taxpayer's stock, does not apply. In addition, the deduction is not disallowed as an impermissible "double deduction", since each deduction claimed by Appellant represented a separate and distinct outlay of cash for which the Code authorized a deduction. Likewise, in no sense was there any "evasion of taxation" under Section 404(k)(5)(A), and, in any event, the Secretary of the Treasury never validly applied Section 404(k)(5)(A) to find such evasion. Summary judgment should have been granted to Appellant, not Appellee.

Section 404(k)(1) allows a deduction for "the amount of any applicable dividend paid in cash by such corporation with respect to applicable employer securities". "Applicable dividends" include dividends that, in accordance with a qualified plan's provisions,⁵ are paid to the plan and distributed to plan participants or their beneficiaries not later than 90 days after the close of the plan year in which the dividends are distributed. Section 404(k)(2)(A)(ii).

Appellee agreed in the District Court that Appellant satisfied all of the requirements of Section 404(k)(1) but one: Appellee contended that the Appellant's payments to the Trust in redemption of its stock were not "dividends" as defined in the Code. (A0009-010 (Op.); A0096 (Stips. ¶¶ 39-45); A0553-559 (U.S. Br.).) If those payments were not dividends, then there could be no "applicable dividend," and Appellant's deduction would be disallowed.

Under the Code, a payment in redemption of stock is treated as a dividend if the redemption is considered "essentially equivalent to a dividend"⁶ -- that is, if the redemption does not result in a "meaningful reduction of the shareholder's proportionate interest in the corporation". United States v. Davis, 397 U.S. 301, 313 (1970); see also Johnston v. Comm'r, 77 T.C. 679, 684 (1981). '"The point of the dividend equivalence test is to tax as dividends those redemptions in which the surrender of stock is basically a meaningless transaction signifying no substantial change in the stockholder's ownership rights."' I.R.S. Gen. Couns. Mem. 38,357, available at 1980 WL 131399 (Apr. 21, 1980) (quoting Blount v. Comm'r, 425 F.2d 921, 925 (2d Cir. 1969)). Under Davis, this analysis involves analyzing the shareholder's percentage of ownership in the corporation before and immediately after the redemption. See, e.g., Davis, 397 U.S. at 313; Johnston, 77 T.C. at 684-85.

Applying this test, the District Court correctly held that the payments to the Trust in redemption of stock were dividends.

In addition, like the redemptions here, the redemptions in Boise Cascade and General Mills reduced the trusts' ownership interests in the companies by a fraction of a percent. Complaint of Boise Cascade Corp. ¶ 33, Boise Cascade Corp. v. United States, No. Civ 97-0312-S-BLW (D. Idaho filed July 11, 1997), available at http://pacer.uspci.uscourts.gov/; Stipulation of Facts, Ex. O, General Mills Inc. & Subsidiaries v. United States, No. 06-cv-03547-DSD-SRN (D. Minn. filed June 29, 2007), available at http://pacer.uspci.uscourts.gov. In General Mills the Government did not contest that the payments to the plan were dividends, see 2008 WL 151626, at *2, and in Boise Cascade the Government agreed that, if the trust rather than the plan participants owned the shares, the payments to the plan were dividends, see 329 F.3d at 755. Here there is no dispute that the Trust owned the shares. (A0094 (Stips. ¶ 21).) Therefore, of the three cases that have raised the issue here, the government did not contest the taxpayer's position in two, and the District Court in the third -- this case -- agreed with the taxpayer.

The District Court's holding that the deductions were allowable under Section 404(k)(1) is consistent with the legislative history of the provision. In the early 1980s, Congress concluded that incentives were needed not only to encourage corporations to adopt ESOPs, but also to encourage corporations to pay out earnings on ESOP stock currently to employees. See 129 Cong. Rec. 33, 815 (1983) (statement of Sen. Long) (advocating "encouraging companies to finance newly formed capital so that it is broadly owned, and then encouraging a substantial payout of the earnings on that capital in order to put more purchasing power into consumers' hands"). The tool chosen for the task was the deduction for applicable dividends under Section 404(k)(1). Deficit Reduction Act of 1984, Pub. L. No. 98-369 § 542(a), 98 Stat. 494, 890-91; Tax Reform Act of 1986, Pub. L. No. 99-514 § 1173(a)(1), 100 Stat. 2085, 2515. As a result, Section 404(k)(1) was intended by Congress as an incentive by employers to provide benefits to employees. This intent would be thwarted by the extremely narrow reading of Section 404(k)(1) propounded by Appellee.

For all of these reasons, this Court should hold that Section 404(k)(1) allows the deduction of Appellant's applicable dividends.

Most significantly, the benefit distribution to employees does not occur "in connection with" the reacquisition of stock. Indeed, the District Court acknowledged this point. The Court stated: "The Boise Cascade Court concluded that the benefit distribution was not made in connection with the reacquisition [of stock]. This is correct. . . ." (A0023 (Op.).)⁸

The District Court nevertheless concluded that Section 162(k)(1) disallowed Appellant's deduction. For the reasons stated below, and as held by the Ninth Circuit before the decision below and by the District of Minnesota after the decision below, the applicable dividend is not paid in connection with the redemption of stock. Therefore, Section 162(k)(1) does not disallow its deduction. Boise Cascade, 329 F.3d at 757-58; General Mills, 2008 WL 151626, at *2-*3.

The District Court's conclusion is incorrect because it is based entirely upon the premise that the deduction claimed by Appellant was for "distributions [Appellant] made in redemption of stock". (A0005 (Op.); see also A0022-023 (Op.) ("It is the redemption proceed dividend [the distribution in redemption of the preferred stock] that is the 'dividend' entitled to a deduction under § 404(k)(1).").) Given this premise, the conclusion of the District Court is understandable -- namely, if the deduction is being claimed for a payment in redemption of stock, and Section 162(k) disallows a deduction for payments made in connection with a redemption of stock, then the payment occurs in connection with a redemption of stock and is therefore disallowed under Section 162(k).

The premise of the District Court, however, is erroneous as a matter of law. Appellant did not claim a deduction for the payment it made in redemption of its stock. Nothing in the Code, including Section 404(k)(1), allows such a deduction. On the contrary, Appellant claimed a deduction under Section 404(k)(1) for the "applicable dividend" -- that is, a dividend that is "paid to the plan and is distributed in cash to participants in the plan or their beneficiaries not later than 90 days after the close of the plan year in which paid". 26 U.S.C. § 404(k)(1), (k)(2)(A)(ii).

Under the statute, two transactions must occur in order for the applicable dividend to exist: the payment to the plan and the benefit distribution to participants. Thus, the deduction for an applicable dividend is not triggered merely by the redemption payment made by Appellant to the trust. Rather, the deduction requires both the redemption payment and the plan's distribution of benefits to the participant, and therefore the deduction is not triggered unless and until the benefit distribution to participants has occurred. As noted above, the District Court acknowledged that the second transaction, the benefit distribution to participants, is not "in connection with" the redemption. (A0023 (Op.).)

Therefore, the deduction is based in critical part on an action (the distribution of cash benefits to participants) that is entirely separate from the redemption of stock. Consequently, the deduction for applicable dividends cannot be said to be for amounts paid "in connection with" the redemption of the taxpayer's stock, and therefore Section 162(k) cannot apply.

The distinction between the redemption payment made to the Trust (that the District Court erroneously viewed as the amount being deducted) and the applicable dividend (that Appellant in fact deducted) is not merely a matter of semantics. The two items are different from each other in numerous respects.

• The benefit payments by the plan to employees arose entirely from the employer-employee relationship and represented the rights of employees under the terms of the plan. These rights of employees to payments did not depend in any way on whether or not Appellant chose to redeem any stock held by the plan. The employees were completely indifferent as to whether any such redemption occurred.

• No matter how large the redemption of stock, the applicable dividend under Section 404(k)(1) is limited to the amount of the benefit payments to employees. If the payment is not made to employees for any reason, there is no applicable dividend and no deduction.

• Even if the redemption of stock is followed by a benefit payment to employees, if the payment to the employees occurs in the next tax year of the employer, the employer's deduction arises only in the year in which the payment to employees is made, not in the earlier year in which the redemption occurred. Section 404(k)(4)(A). For example, if the redemption of stock occurred on December 1, 2000, and the benefit payment to employees occurred on January 15, 2001, an employer with a calendar year tax year would be entitled to the deduction only for its 2001 tax year. This demonstrates that the critical factor for an applicable dividend under Section 404(k)(1) is the payment to employees.

• While a benefit payment to employees is essential to an applicable dividend under Section 404(k)(1), a redemption of stock is not. Section 404(k)(1) does not by its terms require a redemption of stock. Rather, it requires only that a "dividend" be distributed by Appellant to the Trust and be paid to employees. Appellant chose to distribute the dividend pursuant to a stock redemption. However, the stock redemption was merely one alternative method for the Trust to receive cash from Appellant to make benefit payments to employees that would result in an applicable dividend.

• There was no necessary connection between Appellant's redemption of its stock and the benefit payments to employees. Under the Plan, the Trust was required to make the benefit distribution to employees when required, whether or not Appellant redeemed the stock. Likewise, Appellant could decline to redeem stock to finance the Trust's benefit distribution to employees, or Appellant could redeem more of its stock than was needed for the Trust's benefit distribution to employees. If Appellant did not redeem the stock, the Trust would have been required to use other cash to make the benefit payment, such as by raising cash through the conversion of Preferred Stock into common stock and selling common stock on the market. (A0403 (Bestfoods Savings/Retirement Plan); A0186-187 (Certificate of Designations).) To be sure, Appellant had a standing direction to the Trust to request a stock redemption from Appellant when the Trust needed funds to pay employees. But this was merely for administrative convenience, and Appellant could have rescinded this direction at any time.

Thus, the District Court had only a single quarrel with Boise Cascade -- unlike Boise Cascade, the District Court viewed the deduction as being for the dividend paid to the plan, rather than as being for the "applicable dividend". However, since Section 404(k)(1) clearly allows the deduction for the applicable dividend, not the dividend paid to the plan, the Boise Cascade court was correct on this critical issue. Likewise, since the redemptions of stock, on the one hand, and the benefit payments to employees by the Trust, on the other, are segregable transactions, the "applicable dividends" are not "in connection with" the reacquisition of stock and Section 162(k) does not bar their deduction. Boise Cascade, 329 F.3d at 757-58; see also General Mills, 2008 WL 151626, at *3. Consequently, consistent with the District Court's position that the benefit payment to employees is not in connection with the redemption of stock, Appellant's deduction of the applicable dividend should not be disallowed by Section 162(k).

The case law outside the Section 404(k)(1) context also strongly supports Appellant's position that Section 162(k) does not apply when an essential element of the deduction is not connected to a redemption of stock. Every case (other than the decision below) that has disallowed a deduction under Section 162(k) has involved deductions arising solely as a consequence of a stock redemption. See, e.g., Custom Chrome, Inc. v. Comm'r, 217 F.3d 1117 (9th Cir. 2000); UNUM Corp. v. United States, 130 F.3d 501 (1st Cir. 1997); Kitchen Kaboodle II, Inc. v. United States, No. CV-96-472-ST, 1997 WL 416356 (D. Or. May 6, 1997). In UNUM Corp., a mutual life insurance company "demutualized", converting its policyholders' ownership interests into stock in the new company. UNUM Corp., 130 F.3d at 502. The company sought to deduct, in relevant part, the cash it paid to former policyholders who elected to receive cash instead of stock in exchange for their ownership interest. Id. at 504, 506. The First Circuit held that Section 162(k) disallowed the deduction, reasoning that there was "a clearly established nexus" between the redemption of the policyholders' ownership interest and the payment. Id. at 512. This result is plainly correct, because the company sought a deduction for the redemption payment itself. The company did not point to any trigger for the claim other than the redemption.

The District Court's erroneous focus solely on the distributions made by Appellant to the Trust -- and its disregard for the benefit payments made by the Trust to employees, without which Appellant could not claim any deduction -- led it to "contrast[] the reasoning and holding" of Boise Cascade with that of UNUM Corp. and to rely erroneously on the latter. (A0021, A0025-026 (Op.).) But the two cases are not inconsistent. They evaluate different facts, and this case matches the facts of Boise Cascade, not those of UNUM Corp.

Here -- just as in Boise Cascade and General Mills -- Appellant seeks a deduction for applicable dividends. Without the benefit distributions from the Trust to employees, there would be no applicable dividend and no deduction. The amount deductible and the year in which the deduction may be taken are both determined by the benefit distributions to employees, not by the redemptions. Section 404(k)(2)(A)(ii), (k)(4)(A). The redemptions alone are not sufficient to permit a deduction, as the taxpayer claimed they were in UNUM Corp. Thus, UNUM Corp. does not apply here.

The legislative history of Section 162(k)(1) also demonstrates that the statute was intended to disallow only deductions claimed solely as a consequence of a stock redemption (as opposed to deductions that require both a stock redemption and an unrelated action). The legislative history focuses solely on circumstances in which corporations had claimed deductions solely as a consequence of the redemption of their stock. Specifically, the legislative history mentions corporations that take "the position that expenditures incurred to repurchase stock from stockholders to prevent a hostile takeover of the corporation by such shareholders -- so-called 'greenmail' payments -- are deductible business expenses". See H.R. Rep. No. 99-426, at 248 (1985), reprinted in 1986-3 (Vol. 2) C.B. v, 248.

The legislative history also demonstrates that Congress did not intend to bar deductions for transactions that bear merely any relationship to a redemption of stock. It specifically states that Section 162(k)(1) should not disallow a deduction merely because the otherwise deductible amount is "proximate in time or arising out of the same general circumstances" as a redemption of stock. H.R. Conf. Rep. No. 99-841, at II-168 (1986), 1986 U.S.C.C.A.N. 4075, 4256, reprinted in 1986-3 (Vol. 4) C.B. v, 168, quoted in Boise Cascade, 329 F.3d at 757. Rather, Section 162(k) disallows only payments that are "necessary or incident to the repurchase" of stock. H.R. Rep. No. 99-426, at 249 (1985), reprinted in 1986-3 (Vol. 2) C.B. at 248, cited in Boise Cascade, 329 F.3d at 758. The legislative history also states that "if a corporation redeems a departing employee's stock and makes a payment to the employee in discharge of the corporation's obligations under an employment contract, the payment in discharge of the contractual obligation is not subject to disallowance under [Section 162(k)]". H.R. Conf. Rep. No. 99-841, at II-168-II-169 (1986), 1986 U.S.C.C.A.N. at 4256-57, reprinted in 1986-3 (Vol. 4) C.B. at 168-69 (citing favorably William C. Atwater & Co. v. Comm'r, 10 T.C. 218, 247 (1948), which held that a corporation's payment to a shareholder-employee under an agreement to repurchase shares upon termination of employment was deductible to the extent the payment represented additional compensation for services).

Likewise, the history of the enactment and amendment of Section 404(k) illuminates the point. As noted, Section 404(k) was enacted in 1984. Deficit Reduction Act of 1984, Pub. L. No. 98-369 § 542(a), 98 Stat. 494, 890-91. Section 162(k)(1) was enacted in 1986 to reaffirm the general prohibition on deducting payments in redemption of stock. Tax Reform Act of 1986, Pub. L. No. 99-514 § 613, 100 Stat. 2085, 2251. But Congress did not then narrow Section 404(k) by amending it to state that a redemption of stock could not give rise to an applicable dividend. On the contrary, it expanded Section 404(k) by expanding the category of applicable dividends to include amounts used by an ESOP to make payments on an ESOP loan. Id. § 1173(a)(1), 100 Stat. at 2515. Congress obviously did not consider deducting applicable dividends following the redemption of stock under Section 404(k)(1) to be inconsistent with Section 162(k).

On the facts before them, Boise Cascade and General Mills held that Section 162(k) did not bar deduction of the applicable dividends otherwise deductible under Section 404(k)(1). See Boise Cascade, 329 F.3d at 758; General Mills, 2008 WL 151626, at *3. The facts here are virtually the same as in those cases. As in those cases, the origin of the claim here is the election of terminating employees to receive cash payments of the values of their accounts -- not the decision of the taxpayer to redeem stock. (See A0128 (Trust Agreement); A0208-209 (1991 Letter to Trustee).) As in those cases, the existence of the applicable dividends is not "necessary or incident to the repurchase" of Appellant's stock. H.R. Rep. No. 99-426, at 248 (1985), reprinted in 1986-3 (Vol. 2) C.B. at 249.

Indeed, the fact that the Trust was obligated to pay benefit distributions to employees regardless of whether any redemption took place means that here there is even less of a "connection" between the stock redemptions and the benefit payments to employees than there was in Boise Cascade. In Boise Cascade, the ESOP was required to redeem Preferred Stock upon an employee's termination of employment. 329 F.3d at 752. Here, in contrast, there was no such requirement. (A0084 (Solinga Declaration).) The Trust could have satisfied its obligation to the employee by converting its Preferred Stock to common stock and selling it on the market, as the Certificate of Designations concerning the Preferred Stock explicitly provides, or the Trust could have used other cash contributed by Appellant. (See A0186-187 (Certificate of Designations).) That Appellant instructed the Trust on how to process payment requests from members does not change these facts. (See A0208-209 (1991 Letter to Trustee).) Such an instruction was reversible at any time.

This Court, like its sister circuits, has long held that the decisions of other circuits interpreting federal tax law should be followed "where we cannot say that the other courts which have considered the problem have clearly misconstrued the law". Stockly, 221 F.2d at 748. See also Square D Co. & Subsidiaries v. Comm'r, 438 F.3d 739, 744 (7th Cir. 2006) ("As a general matter, '[r]espect for the decisions of other circuits is especially important in tax cases because of the importance of uniformity, and the decision of the Court of Appeals of another circuit should be followed unless it is shown to be incorrect.'" (citation omitted)); Hill v. Comm'r, 204 F.3d 1214, 1217-18 (9th Cir. 2000) (same); Nickell v. Comm'r, 831 F.2d 1265, 1270 (6th Cir. 1987) (same); Gibraltar Fin. Corp. of Cal. v. United States, 825 F.2d 1568, 1572 (Fed. Cir. 1987) (same); N. Am. Life & Cos. Co. v. Comm'r, 533 F.2d 1046, 1051 (8th Cir. 1976) (same); Grimland v. United States, 206 F.2d 599, 601 (10th Cir. 1953) (same). The Ninth Circuit did not clearly misconstrue the law or err in any way, nor did the District of Minnesota.

However, Appellee argued in the District Court that allowing deductions for the applicable dividends would be allowing improper "double deductions" for the same economic cost. The first of the alleged "double deductions" is Appellant's deduction referred to above for the contributions made and dividends paid to the Trust for the purpose of making interest and principal payments on loans incurred to purchase the Preferred Stock held by the Trust. See Section U.S.C. § 404(a)(9)(A)-(B), (k)(1). The second of the alleged "double deductions" is Appellant's deduction for the "applicable dividends" at issue in this case. See Section 404(k)(1). The District Court did not address this issue.

Appellee's double-deduction argument was rejected by the district court in Boise Cascade and the government chose not to press the issue on appeal. See Boise Cascade Corp. v. United States, No. CIV. 97-0312-S-BLW, 1998 WL 877646, at *7 (D. Idaho Nov. 24, 1998); Brief for the Appellant, Boise Cascade Corp. v. United States, No. 01-36086, 2002 WL 32103625, at *7 n.5 (9th Cir. filed Mar. 25, 2002). Appellee's double-deduction argument was also rejected by the court in General Mills, 2008 WL 151626, at *2 n.8. As that court recognized, "A double deduction occurs when a taxpayer is twice allowed a deduction for the same expenditure or loss." Id. That is not the situation here. Appellant seeks two deductions for two separate expenditures: the contribution to the Trust used to service the ESOP loans, and the payment of the applicable dividend. Each expenditure represented a separate and distinct outflow of cash by Appellant, and each expenditure was deducted by Appellant under separate sections of the Code that allowed the respective deductions. Thus, Appellee's position that there is a double deduction is wrong.

Appellant is not in the position of taxpayers in cases such as Charles Ilfeld Co. v. Hernandez, 292 U.S. 62 (1934). There, the taxpayer attempted to deduct its subsidiary's business losses twice -- first as operating losses on its consolidated return against the parent's income and second as investment losses when the subsidiaries were liquidated. Id. at 68. Here, Appellant incurred two entirely separate "real" cash outlays.

Appellee also argued that a double deduction exists as an economic matter (even if not as a technical matter) on the theory that Appellant is deducting both the initial value of the preferred stock (through its deduction of cash contributed to the plan to pay off loans used by the plan to purchase the stock) and cash used to redeem the Preferred Stock. However, Appellee misunderstands the deduction at issue. Appellant does not seek to deduct the cash used to redeem the Preferred Stock. Appellee seeks to deduct the "applicable dividend" -- the dividend that is "paid to [the ESOP] and is distributed in cash to participants in the plan or their beneficiaries not later than 90 days after the close of the plan year in which paid". Section 404(k)(1), (k)(2)(A)(ii).

In any event, even if Appellee's characterization of the deduction for applicable dividends were correct (which it is not), we are aware of no authority stating that two deductions, each representing independent real cash outlays and specifically allowed by the Code, are not both allowed even if together they constitute an "economic" double deduction. Such a rule would require economic analysis of every deduction taken by a taxpayer to determine whether, under some economic theory, the deduction is economically equivalent to some other deduction claimed by the taxpayer. This novel interpretation of the Code would have far-reaching and unpredictable consequences throughout the tax law.

Even more significantly, Appellee's theory of economic double deductions is completely inconsistent with the fact that Section 404(k)(1) already unquestionably allows an economic double deduction. Section 404(a)(9)(A)-(B) unquestionably allows deductions for an employer's contributions to an ESOP that are used by the ESOP to purchase stock, and Section 404(k)(1) unquestionably allows deductions for "regular" dividends on the same stock that are paid to the ESOP and distributed to employees. As an economic matter, however, the value of any stock already includes the present value of the dividends expected to be paid on that stock over time. This point was specifically acknowledged in this very context by the Service in T.D. 9282, Dividends Paid Deduction for Stock Held in Employee Stock Ownership Plan, 2006-2 C.B. 512, 514 (acknowledging that "the present value of expected future dividends is an element of the value of shares of stock at any point in time"). Thus, the employer is unquestionably allowed to deduct under Section 404(k)(1) applicable dividends that, as an economic matter, were already deducted as part of the purchase price for the stock. Congress clearly intended this result, and the Service does not and cannot challenge it. As a result, since some economic double deductions are clearly allowed, then under the theory of Appellee, courts must somehow draw the line between permissible and impermissible economic double deductions, all of which are specifically allowed by the Code.

In fact, Appellee conceded in the District Court that even under its theory, the "applicable dividends" are not double deductions to the extent they represent the value of the appreciation in Appellant's stock between the sale of the stock to the Trust and its redemption. (A0586 (U.S. Reply Brief).)⁹ This concession was necessary because Appellant had never deducted the amount of such appreciation at any time prior to the redemption of stock. Thus, under Appellee's analysis, even if two deductions are in the category of potentially impermissible double deductions (as opposed to permissible double deductions), the potentially impermissible double deductions would be subject to a detailed factual and economic analysis in each case to determine how much of them were in fact "double deductions".

There is no basis whatever in the Code or the case law for this extra-statutory economic analysis of double deductions. In fact, the Supreme Court has held that when two deductions are permitted under the plain language of the Code, both deductions are allowed even if they may result in a "double windfall" with respect to the same economic cost. See Gitlitz v. Commissioner, 531 U.S. 206 (2001), stating that:

Second, in Gitlitz, the double tax benefit arose from the interrelationship of two Code sections that was probably inadvertent on the part of Congress. See 531 U.S. at 219-20 & n.10. The Court held that, even in that case, the double benefit would be allowed unless and until Congress declared otherwise. Id. Here, Congress intended to encourage corporate adoption of ESOPs by allowing deductions both for payments made to service ESOP loans and for applicable dividends. See Section 404(a)(9)(A)-(B), 404(k)(1). Again, since both deductions in question were allowed in Gitlitz, there is even more reason for them to be allowed here.

The reality is that Congress, in enacting Section 404(k)(1), explicitly contemplated each deduction that the government here claimed is "double". Appellant laid out cash equal to the full amount of each deduction claimed. The District Court in Boise Cascade and the court in General Mills properly rejected the double deduction theory, and this Court should as well.

Appellee's argument is meritless. First, revenue rulings are not determinations by the Secretary within the meaning of Section 404(k)(5)(A). See General Mills, 2008 WL 151626, at *4. Second, Revenue Ruling 2001-6 is not entitled to Chevron or any other level of deference. Third, this Court should reject the conclusion of Revenue Ruling 2001-6 on the merits.

A. Revenue rulings are not determinations by the Secretary within the meaning of Section 404(k)(5)(A).

Section 404(k)(5)(A) authorizes a determination to be made by the "Secretary". The District Court in General Mills held that Revenue Ruling 2001-6 was not a determination by the Secretary within the meaning of Section 404(k)(5)(A). See General Mills, 2008 WL 151626, at *4. This Court should do the same.

Within the Code, the term "Secretary" means "the Secretary of the Treasury or his delegate". Section 7701(a)(11)(B). Revenue Rulings such as Revenue Ruling 2001-6 are prepared and issued by the Office of the Chief Counsel. See Internal Revenue Manual ("IRM") 1.1.6.1(2) ("The Office of Chief Counsel prepares . . . revenue rulings. . . ."); IRM 8.14.1.1 ("Revenue rulings are issued by the Office of Associate Chief Counsel"); IRM 30.3.2.3.1.1(1) (delegating to Associate Chief Counsels responsibility for preparing Revenue Rulings).

Because the Code authorizes only the Secretary or his delegate to make determinations under Section 404(k)(5)(A), and Appellee argues that the Chief Counsel issued Revenue Ruling 2001-6 making such determination, the burden lies with Appellee to demonstrate that the Chief Counsel has been delegated the authority to make such determination. Appellee cannot do so.

The powers delegated to the Chief Counsel pursuant to statute do not encompass this authority. The Chief Counsel holds the authority "to furnish legal opinions for the preparation and review of rulings and memoranda of technical advice", "to prepare, review, and assist in the preparation of proposed legislation, treaties, regulations, and Executive orders", to represent the Commissioner in the Tax Court, and to determine which civil tax actions should be litigated. Section 7803(b)(2). In contrast, the Commissioner of Internal Revenue is delegated the authority to "administer, manage, conduct, direct, and supervise the execution and application of the internal revenue laws". Section 7803(a)(2) (emphasis added). In light of the far greater power given to the Commissioner, the statutory powers given to the Chief Counsel cannot be understood to include the authority to determine under Section 404(k)(5)(A) that a dividend constitutes, in substance, an evasion of taxation.

Furthermore, Appellee has never pointed to any non-statutory delegation of such authority to the Chief Counsel. As stated in General Mills, "no record evidence establishes that the Secretary internally delegated his authority under § 404(k)(5)(A) to the Chief Counsel. In the absence of such evidence, Revenue Ruling 2001-6 cannot be considered a determination by the Secretary." 2008 WL 151626, at *4. Accordingly, Section 404(k)(5)(A) has no application to this case.

It is entirely sensible that the Secretary has not delegated to the Chief Counsel the authority to determine "evasion of taxation" under Section 404(k)(5)(A). The concept of "evasion of taxation" presumably refers to particular actions by the taxpayer that result in evasion of taxation by the taxpayer. Such factual determinations are made by IRS agents upon the audit of taxpayers. Such IRS agents are not in the Chief Counsel's office. In contrast, the Chief Counsel primarily issues regulations and rulings of general application to taxpayers. The Chief Counsel does not audit taxpayers or make individual determinations of tax evasion by particular taxpayers. As a result, there is no reason that the Chief Counsel should be delegated the authority under Section 404(k)(5)(A) to determine whether a dividend in a particular case constitutes, in substance, an evasion of taxation.

B. Revenue Ruling 2001-6 is not entitled to any deference.

This Court should not grant Revenue Ruling 2001-6 any deference. Indeed, while the government in Boise Cascade noted in passing that Revenue Ruling 2001-6 had been issued, it did not even attempt to argue that the ruling should be subject to deference, see Brief for Appellant, Boise Cascade Corp. v. United States, No. 01-36086, 2002 WL 32103625, at *10 n.6 (9th Cir. filed Mar. 25, 2002), and the court in Boise Cascade certainly did not grant it any deference.

This Court should not grant Chevron deference to a revenue ruling. First Chi. NBD Corp. v. Comm'r, 135 F.3d 457, 459 (7th Cir. 1998) (Posner, J.) (concluding that revenue rulings are not entitled to Chevron deference); Schlumberger Tech. Corp. & Subsidiaries v. United States, 55 Fed. Cl. 203, 211 n.5 (Fed. Cl. 2003) (revenue rulings are "beyond the Chevron pale" (internal quotation marks omitted)); McLaulin v. Comm'r, 115 T.C. 255 (2000) ("We generally treat a revenue ruling as merely the Commissioner's litigating position not entitled to any judicial deference or precedential weight."). In United States v. Mead Corp., 533 U.S. 218 (2001), the Court explained that Chevron deference for an agency interpretation is appropriate when the interpretation is adopted in compliance with formal administrative procedures contained in the relevant statute that "tend[] to foster the fairness and deliberation that should underlie a pronouncement" having the force of law. 533 U.S. at 230. Thus, "the overwhelming number of our cases applying Chevron deference have reviewed the fruits of notice-and-comment rulemaking or formal adjudication". Id. For example, this Court recently applied Mead to hold that the validity of a Treasury regulation should be evaluated under Chevron because "the Secretary opened the rule to public comment, a move that is indicative of agency action that carries the force of law". Swallows Holding, Ltd. v. Comm'r, No. 06-3388, 2008 WL 427649, at *5 (3d Cir. Feb. 15, 2008).

A revenue ruling, however, is unilaterally adopted by the Service of its own accord without any notice and comment period, and merely states the litigation position of the Service. The first time that taxpayers learn about a revenue ruling is after the final text has been published by the Service. There is no opportunity to comment, either before or after the ruling is published. Thus, there is nothing about the adoption of a revenue ruling that indicates any procedure that "tend[s] to foster the fairness and deliberation that should underlie a pronouncement" having the force of law. Revenue rulings do not merit Chevron deference.

Some courts have afforded revenue rulings a weaker form of deference known as "Skidmore deference", under which agency interpretations are afforded deference based on the validity of their reasoning, their consistency with other pronouncements and their overall persuasiveness. See Skidmore v. Swift & Co., 323 U.S. 134, 140 (1944). Courts have been very willing, however, to evaluate revenue rulings critically, and, if appropriate, reject them. See Reese Bros. v. United States, 447 F.3d 229, 237, 238 (3d Cir. 2006) (explaining that courts may disregard revenue rulings that conflict with statute or are otherwise unreasonable); OfficeMax, Inc. v. United States, 428 F.3d 583, 594 (6th Cir. 2005) (explaining that minimal analysis in revenue ruling "does not contain the traditional hallmarks for receiving deference, whether under Chevron, or under Skidmore"); Bencivenga v. W. Pa. Teamsters & Employers Pension Fund, 763 F.2d 574, 580 (3d Cir. 1985) (rejecting position of revenue ruling); Baker v. Otis Elevator Co., 609 F.2d 686, 691-92 (3d Cir. 1979) (distinguishing legislative rules from interpretive rules).

Under these standards, Revenue Ruling 2001-6 falls far short of being entitled to either Chevron or Skidmore deference.

C. This Court should reject the holding of Revenue Ruling 2001-6 on the merits.

Even aside from any deference, this Court should reject the conclusion of the ruling for several reasons. First, the ruling concludes that the "deduction" would be an evasion of taxation. This does not meet the requirement of the Code -- that the Secretary determine that the "dividend" is an evasion of taxation.

Second, the ruling contains no analysis to support any conclusion concerning evasion of taxation under Section 404(k)(5)(A). After noting that Section 404(k)(5)(A) authorizes the Secretary to disallow a deduction for an applicable dividend that constitutes an evasion of taxation, the ruling simply states that a deduction like the one claimed here would constitute an evasion of taxation. The Court should disregard the conclusory assertion that an evasion of taxation exists.

Third, Appellee argued in the District Court that the justification for the application of the Secretary's authority under Section 404(k)(5)(A) is contained in the paragraph of the ruling that precedes the reference to Section 404(k)(5)(A). This is far from a natural reading of that paragraph, which appears to be an interpretation of the statute rather than an exercise of discretionary authority.

Finally, even if Appellee is permitted to treat the analysis in that preceding paragraph as the alleged justification for the conclusion in the ruling under Section 404(k)(5)(A), the analysis in that paragraph is very unconvincing. That paragraph states that the treatment of redemption proceeds as applicable dividends "would produce such anomalous results that section 404(k) cannot reasonably be construed as encompassing such payments". Those are strong words, but the ruling then goes on to list only two allegedly "anomalous results".

The first so-called anomalous result is that the deduction would permit "employers to claim deductions for payments that do not represent true economic costs". It is not clear what this means, since Appellant paid the Trust, and the Trust paid the participants, the full amount of cash equal to the applicable dividend for which it claimed a deduction. Alternatively, this may be an implicit reference to the double deduction argument discussed above. That argument should be rejected for the reasons stated above.

The second alleged "anomalous result" is that allowing the deduction "would vitiate important rights and protections for recipients of ESOP distributions". The contention is that employees would pay higher taxes on distributions from ESOPs in certain circumstances. However, the ruling does not state why allowing an employer a deduction for "applicable dividends" would have any effect on the taxation of employees. It also does not give any reason why an employer's deduction that is clearly allowed by the terms of Section 404(k)(1) is somehow improper (and an "evasion of taxation", no less), because there might be an adverse tax effect on employees. If the latter point is a concern, the solution is to fix the problem from the employees' point of view, either by administrative or congressional action. This is not a reason to claim that the employer, which is merely complying with the clear requirements of Section 404(k)(1), is engaging in an evasion of taxation.

The ruling also gives no basis for the position that the deduction in question involves tax "evasion". Evasion of taxation appears to require "bad" affirmative acts on the part of the taxpayer. See Spies v. United States, 317 U.S. 492, 499 (1943) (providing examples of affirmative acts such as keeping a double set of books, making false entries or alterations, or false invoices or documents, and "any conduct, the likely effect of which would be to mislead or to conceal").¹¹ In addition, Congress later amended the statute to refer to "avoidance or evasion" of taxation, demonstrating that "evasion" was intended to mean something going beyond "mere avoidance".

Here, every action taken by Appellant was indisputably open and above-board and cannot possibly be characterized as evasion of tax. Appellee has never questioned the motives of Appellant in redeeming the stock from the plan, having the plan make benefit payments to employees, or claiming the deduction for applicable dividends. Appellant did not try to "hide" the claimed deduction; on the contrary, it filed a refund claim with the IRS specifically claiming the deduction. As a result, it is difficult to see how any tax "evasion" exists in this case.

Appellee's concern about the evasion of taxation is also contradicted by the fact that, when the Service issued new regulations in 2006 purporting to bar the type of deduction here claimed, it explicitly did so on a prospective basis, and only after the Service's loss in Boise Cascade and the filing of Appellant's complaint. See T.D. 9282, Dividends Paid Deduction for Stock Held in Employee Stock Ownership Plan, 2006-2 C.B. at 516 (codified in relevant part at Treas. Reg. § 1.404(k)-3 and Treas. Reg. § 1.162(k)-1). If the Service had truly been concerned about Appellant's deduction being an evasion of taxation, it could have issued the regulation retroactively.¹²

For all of these reasons, this Court should not hold that Appellant's claimed deduction is an evasion of taxation.

March 4, 2008

² Unless otherwise noted, all Section references are to the Internal Revenue Code of 1986, 26 U.S.C., as in effect in the years in question.

³ Appellee devoted approximately one page of its memorandum in opposition to Appellant's motion for summary judgment (and in support of its own cross-motion) to an argument that factual issues precluded summary judgment in favor of Appellant. (A0565-566 (United States Brief in Support of Cross-Motion for Summary Judgment ("U.S. Br.")).) The District Court correctly held that each issue Appellee raised was inconsequential and decided the case as a matter of law. Appellee took issue with Appellant's redeemed share figures, but those figures are not decisive because Appellee does not disagree with the amount of Appellant's claimed deductions. (A0007 (Op.).) Appellee disputed the size of the largest redemption made, but that redemption is not material because there is no dispute as to the largest redemption that Appellant claimed was part of an applicable dividend. (A0012 (Op.).)

⁴ In Boise Cascade and General Mills, the taxpayers, like Appellant, maintained ESOPs. Boise Cascade, 329 F.3d at 752; General Mills, 2008 WL 151626, at *1. When participants terminated employment and elected to receive cash distributions of their account values, the taxpayers, like Appellant, made payments to the trusts in redemption of the preferred stock allocated to the employees' accounts. Boise Cascade, 329 F.3d at 752-53; General Mills, 2008 WL 151626, at *3. (The taxpayer in General Mills sometimes declined to redeem the stock. General Mills, 2008 WL 151626, at *3.) The trusts then made distributions to employees. The taxpayers, like Appellant, claimed deductions under Section 404(k)(1) for the applicable dividends. Boise Cascade, 329 F.3d at 753; General Mills, 2008 WL 151626, at *1.

⁵ The Savings/Retirement Plan, of which the Plan was a part, was a qualified plan. (A0092 (Stips. ¶ 7).)

⁶ Under Section 316(a), any distribution that is made out of a corporation's earnings and profits and that is treated as a distribution of property to which Section 301 applies, is a dividend. Appellee concedes that the distributions made to the Trust in redemption of Appellant's stock held by the Trust were made out of Appellant's earnings and profits. (A0093 (Stips. ¶ 20).) Under Section 302, redemptions are considered distributions of property to which Section 301 applies unless one of four conditions applies. Appellee argued that one such condition applied: that the redemptions were "not essentially equivalent to a dividend". Appellee concedes that none of the other conditions applies. (A0094-095 (Stips. ¶¶ 30-32).)

⁷ In 1996, Congress amended Section 162(k)(1) effective for tax years ending after September 13, 1995, replacing the words "the redemption of its stock" with "the reacquisition of its stock or of the stock of any related person (as defined in section 465(b)(3)(C))." Small Business Job Protection Act of 1996, Pub. L. No. 104-188 § 1704(p)(1), 110 Stat. 1755, 1886. This amendment does not affect the resolution of this case.

⁸ The Court went on to say that this was of no consequence because the benefit distribution is not a dividend that is deducted under Section 404(k)(1). As discussed above, however, the deduction under Section 404(k)(1) is for the "applicable dividend", which requires the benefit distribution to be made. As a result, the District Court's conclusion that the benefit distribution was not made in connection with the acquisition of stock is alone sufficient reason to conclude that Section 162(k)(1) does not disallow Appellant's claimed deductions.

⁹ In 1989, the Trust purchased 2.2 million shares of Preferred Stock from Appellant for $200 million, or approximately $90.91 per share. (See A0215-218 (Bestfoods 10-K for fiscal year ending December 31, 1997).) Between 1994 and 2000, Appellant redeemed shares at an average cost of approximately $187.84 per share. (See A0453-459, A0462-468, A0471-476, A0479-483, A0486-488, A0491-493, A0496-498 (Amended tax returns on Form 1120X for 1994-2000).)

¹⁰ The section was amended, effective January 1, 2002, to refer to "avoidance or evasion" of taxation. Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. No. 107-16 § 662(b), 115 Stat. 38, 142.

¹¹ The IRM defines evasion as follows:

¹² Section 7805(b) authorizes regulations to prescribe the extent to which they will not be retroactive, so that retroactive regulations are clearly contemplated. Note that in 1996, the Taxpayer Bill of Rights 2, Pub. L. No. 104-168 § 1101, 110 Stat. 1452, 1468-69, amended Section 7805(b) to limit the ability of the Secretary to promulgate retroactive regulations, but those limitations are inapplicable here because they apply only to regulations under statutory provisions enacted after July 30, 1996. Even if the Secretary voluntarily chose to follow the new legislation when not required to do so, the new legislation has an exception for regulations "to prevent abuse" (current Section 7805(b)(3)). If the Secretary were concerned about "evasion of taxation" under Section 404(k)(5)(A), surely this exception could have been relied upon to issue retroactive regulations under the standards of the new legislation.