Swygert, Chief Judge, Cummings, Circuit Judge, and Campbell, Senior District Judge.*fn1 Campbell, Senior District Judge, dissenting.
This appeal involves an asserted $21,897.64 deficiency in income taxes for 1966. The question is whether taxpayer's payments made to satisfy an apparent liability under Section 16(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78p(b)), which requires a corporate insider to surrender to his employer profit from short-swing trading in the corporation's stock, are to be treated as a long-term capital loss or as ordinary and necessary business expense deductible under Section 162(a) of the Internal Revenue Code of 1954. With Judges Dawson and Quealy dissenting, the Tax Court decided that the payments constituted ordinary and necessary business expense. 56 T. C. 1370. In so doing it adhered to its decision in William L. Mitchell, 52 T.C. 170 (1969), refusing to follow the Sixth Circuit, which reversed Mitchell, 428 F.2d 259 (6th Cir. 1970), certiorari denied, 401 U.S. 909, 27 L. Ed. 2d 807, 91 S. Ct. 868. We also reverse the Tax Court.
The facts are not in dispute. The Tax Court found that in 1962 and in 1963 taxpayer James E. Anderson, a vice president of Zenith Radio Corporation, purchased 1,000 shares of Zenith common stock for $14,038.90 under an employee stock purchase agreement. On April 1 and 7, 1966, he sold those shares for $162,923.21, resulting in a capital gain of $148,884.31. On April 11, 1966, he purchased 750 shares of Zenith common stock for $49,312.50 under another employee stock purchase agreement with Zenith.
About a month after the April 11 purchase, Zenith's legal department advised taxpayer that the April 1 and 7 sales and the April 11 purchase fell within the insider, short-swing-profit prohibition of Section 16(b) of the Securities Exchange Act,*fn2 entitling Zenith to the profit realized by taxpayer. Subsequently in 1966, taxpayer paid Zenith $51,259.14, the amount demanded, in two installments.*fn3
In his 1966 tax return, taxpayer treated the $148,884.31 gain realized on the sale of the 1,000 shares of Zenith stock as a long-term capital gain. He also deducted the $51,259.14 he paid Zenith under Section 16(b) as an ordinary and necessary business expense. However, the Commissioner determined that the payments to Zenith should be treated as long-term capital losses rather than ordinary losses, resulting in a deficiency in the amount of $21,897.64. The Tax Court made an ultimate finding of fact that the payments to Zenith were made to preserve taxpayer's employment with Zenith and avoid injury to his business reputation. It held that the payments were an ordinary and necessary business expense, deductible under Section 162(a) of the Internal Revenue Code of 1954.
The issue here is whether the rule of Arrowsmith v. Commissioner, 344 U.S. 6, 97 L. Ed. 6, 73 S. Ct. 71, applies to require that the payments in satisfaction of the 16(b) liability be characterized in the same terms as the profit realized on the sale of the stock, namely as a long-term capital transaction. In Arrowsmith the taxpayers reported distributions in corporate liquidation as long-term capital gains. In a later year, they were required as transferees to pay a judgment rendered against the corporation, and they attempted to treat the payment as an ordinary business loss. Pointing out that this treatment allowed a much larger deduction than capital loss treatment (Id. at 7), the Supreme Court held that the loss was capital because the liability was imposed on taxpayers as transferees of the liquidation distribution assets and not based on any ordinary business transaction of theirs apart from the liquidation proceedings. Id. at 8.
In Mitchell, the Tax Court found the touchstone of the Arrowsmith rule to be an integral connection between the tax transaction in question and the earlier taxable event. 52 T. C. at 174. It could find no such connection because the earlier taxable event was only the sale of stock and not the subsequent repurchase. No liability grew out of the sale, which as soon as it occurred was a "completed transaction," and upon the later purchase "nothing of tax consequence took place." Since the transaction in question--the 16(b) payment--"grew directly and solely from the 'sale-purchase' occurrence, which has only securities law significance," the Tax Court found no integral relationship between the sale and the payment. Id. at 174-175.
The Sixth Circuit concluded that had the Tax Court considered the application of Arrowsmith in United States v. Skelly Oil, 394 U.S. 678, 22 L. Ed. 2d 642, 89 S. Ct. 1379, it would have concluded, as did the Sixth Circuit, that only a capital loss was available to Mitchell. In Skelly Oil, taxpayer reported income subject to a 27 1/2% oil depletion allowance, and in a later year sought to deduct the full amount of refunds it was required to make. The Supreme Court held that "the Code should not be interpreted to allow respondent 'the practical equivalent of double deduction, '" and, hence, that "the deduction allowable in the year of repayment must be reduced by the percentage depletion allowance * * *." 394 U.S. at 684. The Court found the case "really no different" from Arrowsmith, and stated:
"The rationale for the Arrowsmith rule is easy to see; if money was taxed at a special lower rate when received, the taxpayer would be accorded an unfair tax windfall if repayments were generally deductible from receipts taxable at the higher rate applicable to ordinary income. The Court in Arrowsmith was unwilling to infer that Congress intended such a result." Id. at 685.
In our case the Tax Court reconsidered its position but adhered to its view in Mitchell, adding to the reasoning therein that this case was different from Arrowsmith and Skelly Oil because taxpayer did not make the 16(b) payment to Zenith in the same capacity as he sold the stock. That is, "the sale was made by petitioner in his capacity as a stockholder of Zenith. His obligation to make the payment in question arose out of his status as an employee of Zenith. Neither the sale or purchase nor the combination thereof imposed any obligation upon him." 56 T. C. at 1374-1375.*fn4
We conclude that Arrowsmith, with and without the benefit of its interpretation in Skelly Oil,*fn5 is applicable to this case and find the Tax Court's distinctions unpersuasive.
Although no 16(b) liability would have attached had taxpayer simply sold his stock and not made an advantageous repurchase within six months, the fact that liability is predicted on the sale-purchase occurrence does not mean the 16(b) payments were not integrally related to the earlier sale. It certainly seems the most apt characterization to say that the payments represent a portion of the sales proceeds, and adjustment on the sale price. The amount of liability is calculated by subtracting from the sales proceeds the lowest purchase price within the six-month period.*fn6 Gratz v. Claughton, 187 F.2d 46, 50-52 (2d Cir. 1951), certiorari denied, 341 U.S. 920, 95 L. Ed. 1353, 71 S. Ct. 741; Smolowe v. Delendo Corp., 136 F.2d 231, 239 (2d Cir. 1943), certiorari denied, 320 U.S. 751, 88 L. Ed. 446, 64 S. Ct. 56; II Loss, Securities Regulation, 1062-1063 (1961). And notably interest on the 16(b) payments may be required from the date of the sale preceding the purchase.*fn7 B. T. Babbitt, Inc. v. Lachner, 332 F.2d 255, 258 (2d Cir. 1964).
Furthermore, the Tax Court has given only dubious, conceptual justification for isolating the earlier sale from the payments in question and insulating the latter from capital transaction treatment. After all, as the dissenting opinion of the Tax Court noted, the 16(b) payments were "inextricably intertwined with taxpayer's April 1966 stock transactions." Bifurcating the sale and payments smacks of artificiality, and characterizing the sale-purchase occurrence as without tax significance could only have been done in a vacuum. Since there is hardly anything inevitable about whether the 16(b) payments inherit the capital character of the sale transaction, we think the purpose and operation of Section 16(b) relevant to the determination. "Congress intended the statute to curb manipulative and unethical practices which result from the misuse of important corporate information for the personal aggrandizement or unfair profit of the insider." Bershad v. McDonough, 428 F.2d 693, 696 (7th Cir. 1970), certiorari denied, 400 U.S. 992, 27 L. Ed. 2d 440, 91 S. Ct. 458. In its operation "* * * the statute was intended to be throughgoing, to squeeze all possible profits out of stock transactions * * *" within its embrace. Smolowe v. Delendo Corp., 136 F.2d 231, 239 (2d Cir. 1943). If an insider taxpayer may through short-swing trading realize profit taxable at favorable capital gains rates, and then take an ordinary business expense deduction when he disgorges part of that profit under 16(b), he may profit handsomely from his short-swing dealing.*fn8 Indeed, in the instant case, if the taxpayer were allowed to offset his $51,259.14 payments against ordinary income, he would receive a net tax profit of $21,897.64 as a result of his short-swing trading. Thus the ...