Grand Forks herald. [volume] (Grand Forks, N.D.) 1916-1955, 1922-12-15
SURPLUS, STOCK AND DIVIDENDS

SURPLUS, STOCK AND DIVIDENDS
The supreme court has ruled that stock divi-
dends are not taxable, and the decision has brought
forth much protest. The character of many of these
protests reveals an exceedingly hazy idea as to the
nature of corporate organization and corporate
Financing. : . -. w.
The present internal revenue law deals with
the question of the corporate surplus, the character
of which may be illustrated by a concrete example.
A corporation is organized with a capital Of $780,
900 in shares of the par value of 500, for which the
holders have paid the face value in cash. The bust
ness proves profitable, and it has good prospects of
expansion. In order to expand, however, more
capital is needed, and the owners, instead of draw
ing their profits an cash dividends, leave ali the
profits in the business. This fund is carried as a
separate item, and us known as the surplus. 1t may
be used in the erection of buildings, purchase of
machinery, or in any other way for the promotion
Of the business. Part Of it may be held in cash to
serve as additional working capital.
The law provides that this surplus shall not be
taxed as if it were private income for the very good
reason that it is not private income. But there is
the proviso that it shall not be exempt if it is allow
ed to reach larger proportions than are necessary.
for the proper operation of the business. If it ap-
|pears that the accumulation of surplus is merely
for the purpose of evading taxation, it is taxable.
The corporation continues to set aside money
in its surplus fund until its surplus has equaled the
amount of it's capital stock, and then; because it is
invested in the business in permanent. form, and
division is impracticable, and for reasons of con-
venience, it is decided to transform this surplus into
permanent capital. In the case supposed this would
be done by voting a stock dividend of 100 per cent.
which might represent the accumulations of many
years. The holder of each share Of old stock would
be given one share of new stock. Here is where the
lconfusion comes in. ,
The corporation owns no more property than it
die before. The individual stakeholder is not en-,
|riched by so much as a penny. His original share
of stock represents the 500 which he paid for it,
and another 500 of accumulated earnings which are
invested in the business. In the years of operation,
many or few, as. the case may be, the value of his
capital had doubled by the process of keeping his
earnings at work in the same business. Now, under
the new arrangement he owns just the same amount
of property, but that property is represented by two
shares of stock instead of one. Yesterday he had
one share of stock which was worth $500. Today
he has two shares of stock which, together, are
worth 5000. His financial condition has not been
changed at all.
, ln-the matter Of cash dividends, if it has been
the custom of the concern to distribute part of its
earnings in cash and to permit the rest to accumu-
late to be used in expansion of the business, suppose
that for a number Of years the corporation has
been in the habit of distributing $4,000 of its earn
Iings in cash dividends. That would mean a divi-
dend Of 5 per cent. When the surplus is changed
to new stock there is still the same $4,000 in cash to
distribute. The amount would not be changed by
the change in the form of the holdings. Instead: of
receiving a dividend Of SIS on his original share, the
stakeholder would receive $3.50 on each of. two
shares. In each case he would receive just $500.
These are some Of. the elementary facts relat-
ing to stock dividends. tits clear that money which
has not passed into the possession OF the individual,
but is used legitimate1y in the operation of a useful
business, should notbe taxed s'private income. The
government passed on all questions of surplus and
Of stock dividends, and decided whether or not in a
given case an attempt Is being made to sevade the
law by keeping undistributed money which is nqt
required for the proper conduct soi the business.
Under these circumstances the taxation. Of such
where It is needed funds which ought to be left
there, and the resultSwoufd be an impairment Of the
prosperity Of the country. 4@Ss
There IS nothi1g very surprising in the story