Boulware v. US
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[edit] Briefs and Documents
Docket: 06-1509
VACATED and REMANDED in an opinion by Justice Souter
- Brief for Petitioner Michael H. Boulware
- Brief for Respondent United States of America
- Reply Brief for Petitioner Michael H. Boulware
Amicus briefs
[edit] Pre-Argument Articles
[edit] Grant write-up
The following summary was written by Shannen Naegel, a tax associate at Akin Gump’s office in Washington, DC.
The Supreme Court on Tuesday agreed to consider whether intent to make a return of capital is required for funds diverted and distributed to a shareholder of a corporation without earnings and profits to qualify as non-taxable return of capital in the context of a criminal trial for tax evasion.
In Boulware, the founder, chairman, and president of Hawaiian Isles Enterprises (HIE), a closely held corporation selling tobacco products, coffee, bottled water, and other goods, was charged with tax evasion and tax fraud in connection with his failure to report funds diverted from HIE. Boulware was convicted on multiple counts, but the Ninth Circuit reversed on the ground that the trial court erroneously excluded evidence of a Hawaii state court’s adjudication of property rights of some of the diverted funds from HIE. The taxpayer was also the majority shareholder of HIE; the other shareholder was a trust for the benefit of his son.
On retrial, Boulware was convicted on all counts. In his second appeal to the Ninth Circuit, Boulware argued, in part, that the funds he received from HIE were non-taxable returns of capital rather than income. The Ninth Circuit held that Boulware did not provide sufficient evidence that the funds were intended as a return of capital at the time of distribution to sustain a return-of-capital defense under the Ninth Circuit case, U.S. v. Miller, 545 F.2d 1204 (1976). In Miller, the Ninth Circuit ruled that where the government establishes a prima facie case that a defendant received and failed to report corporate funds, the burden shifts to the defendant to establish that the funds were intended to be a non-taxable return of capital.
Boulware then petitioned the Supreme Court to review two issues – whether the Hawaii state court adjudication of some of the diverted funds from HIE is controlling and whether evidence of intent is needed to argue return of capital in a criminal case. The petition highlighted the circuit split between the Ninth Circuit’s Miller case and the Second Circuit’s holding that no showing of intent is required for a defendant to invoke a return-of-capital defense (U.S. v. D’Agostino, 145 F.3d 69 (1998)).
In its opposition brief, the government argued that this case was not an appropriate vehicle for resolving the circuit conflict as, in the government’s view, Boulware would likely not prevail under the Second Circuit’s approach because the diversion of funds from HIE to Boulware was unlawful. The D’Agostino case explicitly carves out unlawful distributions from its holding.
The Supreme Court granted Boulware’s petition, but limited its review to the question of “[w]hether the diversion of corporate funds to a shareholder of a corporation without earnings and profits automatically qualifies as a non-taxable return of capital up to the shareholder’s stock basis…even if the diversion was not intended as a return of capital.” This formulation of the question mirrors that of the government’s brief, and is a departure from the question presented in Boulware’s petition.
The Petitioner’s brief and the reply brief are due Monday, November 5 and Monday, December 3, respectively. The case is expected to be argued in January.
[edit] Argument Preview
When a corporation without any profits diverts funds to a shareholder, is this diversion a nontaxable return on capital up to the shareholder’s basis in the corporation under 26 U.S.C. § 301(c)(2), even if the shareholder did not intend it as such? On January 8, 2008, the Supreme Court will consider this question in No. 06-1509, Boulware v. United States.
[edit] Background
26 U.S.C. § 301 provides that a distribution of property from a corporation to a shareholder is taxed as ordinary income if it is a dividend and as a capital gain if it is a return on capital that exceeds basis. However, such a distribution is not taxed if it is not a dividend and does not exceed the shareholder’s basis in the corporation. 26 U.S.C. § 316 in turn defines dividends as distributions of the earnings or profits of a corporation; absent an exception, all distributions are dividends to the extent of the corporation’s earnings or profits. In combination, these statutes establish the “return of capital” rule: a shareholder is not taxed on disbursements of corporate funds when he is merely recovering his basis in the stock.
Petitioner Michael Boulware was the founder, president, and majority shareholder of Hawaiian Isles Enterprises (“HIE”), a closely held corporation selling tobacco, coffee, bottled water, and other goods. Boulware was convicted on several counts of tax evasion and tax fraud arising out of his failure to report approximately $10 million in funds he had diverted from the corporation. However, the Ninth Circuit initially reversed this conviction based on the trial court’s failure to admit the holding of a related state case as evidence concerning the ownership of a portion of the dispersed funds.
On retrial, Boulware was again convicted on all counts, and the Ninth Circuit affirmed on appeal. The Ninth Circuit rejected Boulware’s argument that because the disbursements were a return on capital, there was no tax deficiency upon which to rest a criminal conviction. Relying on its precedent in United States v. Miller, the court of appeals held that the disbursement could not be considered a return on capital unless Boulware could show that he intended them as such when they were made.
[edit] Petition for Certiorari
Boulware filed a petition for certiorari asking the Court to review (1) whether the Hawaii state court adjudication of some of the diverted funds from HIE is controlling and (2) whether evidence of intent is needed to argue return of capital in a criminal case. The petition highlighted the circuit split between the Ninth Circuit’s Miller case and the Second Circuit’s 1998 holding that no showing of intent is required for a defendant to make a return-of-capital defense. Opposing certiorari, the government acknowledged the circuit split but argued that this case was not an appropriate vehicle for resolving it. The government maintained that even if Boulware did not need to show intent to put forward a return-of-capital defense, the case’s outcome would not change because the diversion of funds from HIE to Boulware was unlawful. D’Agostino explicitly carves out unlawful distributions from its holding. The Supreme Court granted Boulware’s petition, but limited its review to the question of “[w]hether the diversion of corporate funds to a shareholder of a corporation without earnings and profits automatically qualifies as a non-taxable return of capital up to the shareholder’s stock basis…even if the diversion was not intended as a return of capital.” This formulation of the question mirrors that of the government’s brief, and is a departure from the question presented in Boulware’s petition.
[edit] Merits Briefing
In his merits brief, Boulware reiterates the arguments he made at the cert. stage concerning the return-of-capital rule. First, he contends that the Ninth Circuit had no statutory basis for creating the Miller contemporaneous intent requirement. Boulware argued that, under the federal statutes, a criminal defendant may rely on a return-of-capital defense as long as he can show that (1) the corporation had no profits; and (2) the shareholder’s basis exceeded the amount distributed. Thus, there is no statutory basis for Miller’s additional requirement that the defendant show that the distribution was intended as a return of capital when made. He also asserts that Miller’s rationale for the contemporaneous intent requirement ignores the statutory requirement that a tax deficiency must exist to prosecute criminal tax evasion cases. In Miller the Ninth Circuit reasoned that criminal tax statutes are concerned with the taxpayer’s intent to file a fraudulent tax return, rather than whether a tax deficiency actually exists. Moreover, Boulware contended that the divergence between civil and criminal law creates the potential for anomalous situations in which a taxpayer has no deficiency under civil law, but can nonetheless be convicted of criminal tax evasion based on a deficiency.
Boulware next turns to the government’s argument that any error was harmless because the return-of-capital defense cannot be asserted when the distributions are unlawful. He contends that Sections 301 and 316 do not distinguish between lawful and unlawful distributions, and although unlawful distributions may have other civil and criminal consequences, this issue is irrelevant to tax treatment under the return-of-capital rule.
Finally, Boulware maintains that even if the government prevails and the return-of-capital rule does not apply to unlawful distributions, a new trial is required to determine whether the distributions at issue in this particular case were lawful or not.
In its brief on the merits, respondent United States argues that, pursuant to Section 301(a), the return-of-capital rule applies only to distributions “with respect to [the corporation’s] stock.” The United States contends that because this phrase “limits return-of-capital treatment to payments that are made to a shareholder by reason of his status as such,” the rule does not apply to shareholders who receive funds in a non-shareholder capacity, such as that of an employee or embezzler.
The United States further contends that failing to impose Miller’s contemporaneous intent requirement would promote fraud. Specifically, it explains, if such fraud is detected, the return-of-capital rule would immunize the shareholder from prosecution; however, if it is not detected, years later the shareholder could again receive corporate funds tax-free as a return of capital. The United States next argues that Miller’s contemporaneous intent requirement does not create a disparity in the tax status of distributions to shareholders in the criminal and civil contexts because both areas of law apply essentially the same “facts and circumstances” test.
Finally, the United States argues that even if the Court were to adopt the D’Agostino test, eliminating Miller’s contemporaneous intent requirement, Boulware would still be guilty because the distribution of funds were unlawful, not “with respect to [the corporation’s] stock,” and thus not subject to the return of capital rule.
Oral argument in the case is scheduled for January 8, 2008.
[edit] Oral Argument Recap
Like the briefs, the oral argument focused on whether Boulware’s diversion of funds was a distribution “with respect to stock.” 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 Circuit’s view; by contrast, several repudiated that circuit’s contemporaneous intent requirement to the extent that it did not conform to the “with respect to stock” 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 shareholder’s basis in the stock.
Justice Ginsburg clarified that the term “with respect to stock” simply meant that there was no expectation that the corporation would receive consideration in return for the payment – e.g., the cancellation of debt or employee services. The government acknowledged that this was “half the understanding” of this phrase, but it emphasized that the other half of the understanding refers to “funds you receive solely because of your status as a shareholder.” Addressing this idea later, Boulware contended that the distribution was indeed “with respect to stock” because it was made solely due to Boulware’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 “with respect to stock,” 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 Circuit’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 “contemporaneous intent” 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 “contemporaneous intent” requirement, the Court next turned to whether the Ninth Circuit’s error was harmless. Although the government argued that Boulware never asserted a “return of capital” defense, Boulware countered that the combination of the application of the “contemporaneous intent” requirement and the trial court’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.
