Source: https://supreme.justia.com/cases/federal/us/247/330/
Timestamp: 2019-04-25 21:47:04+00:00

Document:
Accumulations that accrued to a corporation through surplus earnings or appreciation in property value, before the adoption of the Sixteenth Amendment (February, 1913), and the effective date (March, 1913), of the Income Tax Act of 1913 (Act October 3, 1913, c. 16, 38 Stat. 166), are to be regarded as its capital, not as its income for the purposes of that act.
Although, in general, the Income Tax Act of 1913, unlike that of June 30, 1864, treated corporate earnings as not accruing to the shareholders until the time when a dividend was paid (Lynch v. Hornby, post, 247 U. S. 339), and although in ordinary cases the mere accumulation of adequate surplus does not entitle a shareholder to dividends until the directors, in their discretion, declare them, yet, where the shares of a corporation were all owned, and its property and funds possessed, and its operations and affairs completely dominated, by another corporation, so that the two were in substance but one, and where dividends from the one to the other were consummated, after the Act of 1913 became effective, by a mere paper transaction -- formal vote of the directors of the first company and entries on the books of the two -- and represented merely what the second company was entitled to have as shareholder before January 1, 1913, from a surplus theretofore accumulated, held that such dividends were not taxable as income of the shareholding company within the true intent and meaning of the Income Tax Act of 1913.
This case presents a question arising under the Federal Income Tax Act of October 3, 1913, c. 16, 38 Stat. 114, 166. Suit was brought by plaintiff in error against the Collector to recover taxes assessed against it and paid under protest. There ware two causes of action, of which only the second went to trial, it having been stipulated that the trial of the other might be postponed until the final determination of this one. So far as it is presented to us, the suit is an effort to recover a tax imposed upon certain dividends upon stock, in form received by the plaintiff from another corporation in the early part of the year 1914, and alleged by the plaintiff to have been paid out of a surplus accumulated not only prior to the effective date of the act, but prior to the adoption of the Sixteenth Amendment to the Constitution of the United States. The district court directed a verdict and judgment in favor of the Collector, 238 F. 847, and the case comes here by direct writ of error under § 238, Judicial Code, because of the constitutional question. That our jurisdiction was properly invoked is settled by Towne v. Eisner, 245 U. S. 418, 245 U. S. 425.
The case was submitted at the same time with several other cases arising under the same act and decided this day, viz., Lynch, Collector v. Turrish, ante, 247 U. S. 221, Lynch v. Hornby, post, 247 U. S. 339, and Peabody v. Eisner, post, 247 U. S. 347.
Central Pacific needed money for additions and betterments or for making up a deficit of current earnings, the necessary funds were advanced by the Southern Pacific. As a result of these operations and of the conversion of certain capital assets of the Central Pacific Company, that company showed upon its books a large surplus accumulated prior to January 1, 1913, principally in the form of a debit against the Southern Pacific, which at the same time, as sole stockholder, was entitled to any and all dividends that might be declared, and, being in control of the board of directors, was able to and did control the dividend policy. The dividends in question were declared and paid during the first six months of the year 1914 out of this surplus of the Central Pacific accumulated prior to January 1, 1913, but the payment was only constructive, being carried into effect by bookkeeping entries which simply reduced the apparent surplus of the Central Pacific and reduced the apparent indebtedness of the Southern Pacific to the Central Pacific by precisely the amount of the dividends.
"that there shall be levied, assessed, collected and paid annually upon the entire net income arising or accruing from all sources in the preceding calendar year"
"that the normal tax hereinbefore imposed upon individuals [1 percent] likewise shall be levied, assessed, and paid annually upon the entire net income arising or accruing from all sources during the preceding calendar year to every corporation . . . organized in the United States,"
with other provisions not now material.
It is provided in paragraph G(b) as to domestic corporations that such net income shall be ascertained by deducting from the gross amount of the income of the corporation (1) ordinary and necessary expenses paid within the year in the maintenance and operation of its business and properties, including rentals and the like, (2) losses sustained within the year and not compensated by insurance or otherwise, including a reasonable allowance for depreciation by use, wear and tear of property, if any, and in the case of mines a certain allowance for depletion of ores and other natural deposits; (3) interest accrued and paid within the year upon indebtedness of the corporation, within prescribed limits, (4) national and state taxes paid. It will be observed that moneys received as dividends upon the stock of other corporations are not deducted, as they are in computing the income of individuals for the purpose of the normal tax under this act (p. 167) and as they were in computing the income of a corporation under the Excise Tax Act of August 5, 1909, c. 6, 36 Stat. 11, 113, § 38.
in making the computation any income that accrued in a preceding calendar year, is made plain by the provision last referred to; indeed, the Sixteenth Amendment, under which for the first time Congress was authorized to tax income from property without apportioning the tax among the states according to population, received the approval of the requisite number of states only in February, 1913. Pollock v. Farmers' Loan & Trust Co., 157 U. S. 429, 157 U. S. 581; 158 U. S. 158 U.S. 601, 158 U. S. 637; Brushaber v. Union Pacific R. Co., 240 U. S. 1, 240 U. S. 16.
We must reject in this case, as we have rejected in cases arising under the Corporation Excise Tax Act of 1909 (Doyle v. Mitchell Brothers Co., ante, 247 U. S. 179, and Hays v. Gauley Mountain Coal Co., ante, 247 U. S. 189), the broad content on submitted in behalf of the government that all receipts -- everything that comes in -- are income within the proper definition of the term "gross income," and that the entire proceeds of a conversion of capital assets, in whatever form and under whatever circumstances accomplished, should be treated as gross income. Certainly the term "income" has no broader meaning in the 1913 act than in that of 1909 (see Stratton's Independence v. Howbert, 231 U. S. 399, 231 U. S. 416-417), and, for the present purpose, we assume there is no difference in its meaning as used in the two acts. This being so, we are bound to consider accumulations that accrued to a corporation prior to January 1, 1913, as being capital, not income, for the purposes of the act. And we perceive no adequate ground for a distinction in this regard between an accumulation of surplus earnings and the increment due to an appreciation in value of the assets of the taxpayer.
pertinent to the present inquiry, and hence underwent nothing more than a change of form when the dividends were declared.
"the gains and profits of all companies, whether incorporated or partnership, other than the companies specified in this section, shall be included in estimating the annual gains, profits, or income of any person entitled to the same, whether divided or otherwise."
dividends received by the ordinary stockholder after it took effect but paid out of a surplus that accrued to the corporation before that event, is set forth in Lynch v. Hornby, post, 247 U. S. 339.
the accounts as an indebtedness of the lessee to the lessor, cannot be controlling in view of the practical identity between lessor and lessee. Aside from the interests of creditors and the public -- and there is nothing to suggest that the interests of either were concerned in the disposition of the surplus of the Central Pacific -- the Southern Pacific was entitled to dispose of the matter as it saw fit. There is no question of there being a surplus to warrant the dividends at the time they were made, hence any speculation as to what might have happened in case of financial reverses that did not occur is beside the mark.
It is true that, in ordinary cases, the mere accumulation of an adequate surplus does not entitle a stockholder to dividends until the directors in their discretion declare them. New York, Lake Erie & Western Railroad v. Nickals, 119 U. S. 296, 119 U. S. 306; Gibbons v. Mahon, 136 U. S. 549, 136 U. S. 558. And see Humphreys v. McKissock, 140 U. S. 304, 140 U. S. 312. But this is not the ordinary case. In fact, the discretion of the directors was affirmatively exercised by declaring dividends out of the surplus that was accumulated prior to January 1, 1913; it does not appear that any other fair exercise of discretion was open, and the complete ownership and right of control of the Southern Pacific at all times material makes it a matter of indifference whether the vote was at one time or another. Under the circumstances, the entire matter of the declaration and payment of the dividends was a paper transaction to bring the books into accord with the acknowledged rights of the Southern Pacific, and so far as the dividends represented the surplus of the Central Pacific that accumulated prior to January 1, 1913, they were not taxable as income of the Southern Pacific within the true intent and meaning of the Act of 1913.
raised. Pullman Car. Co. v. Missouri Pacific Co., 115 U. S. 587, 115 U. S. 596; Peterson v. Chicago, Rock Island & Pacific Ry., 205 U. S. 364, 205 U. S. 391.
There was another question, concerning a dividend paid by the Reward Oil Company, whose stock likewise was owned by the Southern Pacific Company, but the contention of plaintiff in error respecting this item has been abandoned.
In addition, a question was made in the district court as to a special dividend declared by the Central Pacific out of the proceeds of sale of certain land on Long Island, taken in satisfaction of a debt and sold in December, 1913. As to this, however, no argument is submitted by plaintiff in error, the facts are not clear, and we pass it without consideration.
"For the purpose of this additional tax, the taxable income of any individual shall embrace the share to which he would be entitled of the gains and profits, if divided or distributed, whether divided or distributed or not, of all corporations, joint-stock companies, or associations, however created or organized, formed, or fraudulently availed or for the purpose of preventing the imposition of such tax through the medium of permitting such gains and profits to accumulate instead of being divided or distributed, and the fact that any such corporation . . . is a mere holding company, or that the gains and profits are permitted to accumulate beyond the reasonable needs of the business shall be prima facie evidence of a fraudulent purpose to escape such tax, but the fact that the gains and profits are in any case permitted to accumulate and become surplus shall not be construed as evidence of a purpose to escape the said tax in such case unless the Secretary of the Treasury shall certify that, in his opinion, such accumulation is unreasonable for the purposes of the business."

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