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.

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