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October Term,
2007
March 3,
2008
Today
the Supreme Court issued one decision, described below, of
interest to the business community.
Boulware v. United States,
No. 06-1509 (previously discussed in the
September 25, 2007 Docket Report). 26 U.S.C. § 7201
makes it a felony willfully to "attemp[t] in any manner to evade
or defeat any tax imposed" by the U.S. Tax Code. Petitioner
Boulware was convicted of criminal tax evasion under Section
7201 for diverting funds from a closely held corporation of
which he was the president, founder, and controlling
shareholder. Boulware attempted to argue that the distributions
he received were nontaxable returns of capital. The Ninth
Circuit, relying upon an earlier decision, held that a diversion
of funds in a criminal tax evasion case may be deemed a return
of capital only if the taxpayer or corporation demonstrates that
the distributions were intended to be such a return. The Supreme
Court, in a unanimous opinion, vacated and remanded, holding
that one of the elements of tax evasion under Section 7201 is
"the existence of a tax deficiency," and the intent of the
taxpayer and the corporation in making the distribution was
irrelevant if Boulware could show that there was no actual tax
deficiency.
Boulware is significant because it prevents a disconnect
between civil and criminal tax liability that the court below
had openly acknowledged and accepted. The Supreme Court held
that if there is no actual tax deficiency under the civil code,
there can be no tax evasion. The Court determined that because
the tax classifications of "dividend" and "return of capital"
turn on the objective economic realities of a transaction rather
than on the form or intent of the parties, a criminal defendant
need not show an intent to treat a distribution as a return of
capital to argue that there was no tax deficiency and,
therefore, no tax evasion.
The allegations in Boulware were "colorful." The
defendant was charged with using various techniques to pull
millions of dollars out of a corporation of which he was the
president, founder, and controlling (though not sole)
shareholder. Whether corporate distributions are nontaxable
returns of capital is governed by 26 U.S.C. §§ 301 and 316(a).
Under Section 301(a), a distribution of property that is "made
by a corporation with respect to its stock" shall be taxed as
income if it is a dividend (as defined by Section 316(a)). If it
is not a dividend, then it is nontaxable up to the shareholder's
basis for his stock, and taxable as a capital gain above that
basis. Section 316(a) defines a dividend as a distribution out
of a company's "earnings and profits of the taxable year." When
Section 301 and 316 are taken together, a distribution with
respect to stock from a company with profits in the past year
will be treated as a taxable dividend, while a distribution from
a company without profits will be treated as a return of capital
and/or a capital gain, depending on the distributee's basis for
the stock.
Boulware attempted to introduce evidence that the corporation
had no retained or current earnings and profits, and therefore
under the civil tax code the distributions he received
constituted nontaxable returns of capital up to his basis in his
stock. The government moved in limine to bar evidence in
support of this theory, arguing that it was irrelevant in a
criminal tax case because, for criminal tax evasion, a diversion
of funds may be deemed a return of capital only after some
demonstration on the part of the taxpayer and/or the corporation
that the distribution was intended to be such a return. The
district court granted the government's motion, and the Ninth
Circuit affirmed. Acknowledging the "disconnect between civil
and criminal liability," the Ninth Circuit nonetheless held that
"the characterization of diverted corporate funds for civil tax
purposes does not dictate their characterization for purposes of
a criminal tax evasion charge." Instead, the Ninth Circuit
reasoned, the test in a criminal case is whether the defendant
"willfully attempted to evade the payment or assessment of a
tax."
The Supreme Court opinion focused on an "analytical mistake" in
the lower court's focus on the "willful intent to evade taxes."
The Court noted that under its prior opinions, one element of
tax evasion under Section 7201 is "the existence of a tax
deficiency." Willfulness is, of course, also an element of tax
evasion, and on that score nothing in the civil code "relieves
the Government of this burden of proving willfulness or impedes
it from doing so." But the civil code is relevant to address "a
different element of criminal evasion, the existence of a tax
deficiency." Sections 301 and 316 function "wholly independent
of intent." Therefore, Boulware did not "need to show a
contemporaneous intent to treat diversions as returns of capital
before relying on those sections to demonstrate no taxes are
owed."
In reaching its conclusion, the Court left open a number of more
specific questions as to whether the diversions in the case
could be nontaxable returns of capital. The Government, before
the Court, had backed away from the Ninth Circuit's differential
treatment of civil and criminal tax liability, instead arguing
that the diversions in the case were not "with respect to
stock," and were unlawful and therefore could not be nontaxable
under Sections 301 and 316. The Court left consideration of
these questions for remand, noting that the facts in this case
were not "raked over" with these questions in mind, and the jury
was never asked whether the funds were unlawfully diverted. |
