Case Name: EISNER, AS COLLECTOR OF UNITED STATES INTERNAL REVENUE FOR THE THIRD DISTRICT OF THE STATE OF NEW YORK, v. MACOMBER
Court: Supreme Court of the United States
Jurisdiction: United States
Decision Date: 1920-03-08
Citations: 252 U.S. 189
Docket Number: No. 318
Parties: EISNER, AS COLLECTOR OF UNITED STATES INTERNAL REVENUE FOR THE THIRD DISTRICT OF THE STATE OF NEW YORK, v. MACOMBER.
Judges: Mr. Justice Day concurs in this opinion.
Reporter: United States Reports
Volume: 252
Pages: 189–238

Head Matter:
EISNER, AS COLLECTOR OF UNITED STATES INTERNAL REVENUE FOR THE THIRD DISTRICT OF THE STATE OF NEW YORK, v. MACOMBER.
ERROR TO THE DISTRICT COURT OP THE UNITED STATES FOR .THE SOUTHERN DISTRICT OF NEW YORK.
No. 318.
Argued April 16, 1919;
restored to docket for reargument May 19, 1919;
reargued October 17, 20, 1919.
Decided March 8, 1920.
Congress was not empowered by the Sixteenth Amendment to tax, as income of the stockholder, without apportionment, a stock dividend made lawfully and in' good faith against profits accumulated by the corporation since March 1,1913. P. 201. Toume v. Mmer, 245 U. S. 418.
The Revenue Act of September 8, .1916, c. 463, 39 Stat. 756, .plainly evinces the purpose of Congress to impose such taxes and is to that . extent in conflict with Art. I, § 2, cl. 3, and Art. 1, § 9, cl. 4, of the Constitution. Pp. 199,217.
These provisions of the Constitution necessarily limit the extension, by construction, of the Sixteenth Amendment. P. 205.
What is or is not “income” within the meaning of the Amendment must be determined in each case according to truth and substance, without regard to form. P. 206.
Income may be defined as the gain derived from capital, from labor, ■ or from both combined, including profit gained through sale or conversion of capital. P. 207.
Mere growth or increment of value in a capital investment is not income; income is essentially a gain or profit .in itself of exchangeable value, proceeding from capital, severed from it, and derived or received by the taxpayer for his separate use, benefit and disposal. Id.
A stock dividend — evincing merely a transfer of an accumulated surplus to the capital account of the corporation — takes nothing from ■the property of the corporation and adds nothing to that of the shareholder; a tax on such dividends is a tax on capital increase and not on income, and to be valid under the Constitution such taxes must be apportioned according to population in the several States. P. 208.
Affirmed.
The case is stated in the opinion.
Mr. Assistant Attorney General Frierson for plaintiff in error:
Stockholders have such an interest in the earnings and profits of a corporation that the same are within the power of Congress to tax as income even before they are divided. Collector v. Hubbard, 12 Wall. 1; Southern Pacific Co. v. Lowe, 247 U. S. 330, 336; Lynch v. Turrish, 247 U. S. 221, 228; Bailey v. Railroad Co., 22 Wall. 604, 635, 636; Lynch v. Hornby, 247 U. S. 339, 343.
The right of Congress to tax undivided profits cannot be destroyed by the issuance of stock certificates to represent them; and, since the certificates of stock in this case represent earnings of the corporation accrued subsequently to March 1, 1913, they are clearly made taxable as income by the Act of 1916, c. 463, 39 Stat. 756. Peabody v. Eisner, 247 U. S. 347; Bailey v. Railroad Co., 22 Wall. 604, 635; Swan Brewery Co., Ltd., v. Rex, [1914] A. C. 231, 234-236.
Towne v. Eisner, 245 U. S. 418, does not control this, case. (1) It merely decides that the stock dividends then before the court, paid out of earnings accrued prior to March 1, 1913, were not income within the meaning of the Act of 1913. Nothing said in the opinion can be construed as challenging the power of Congress to tax, as the income of stockholders, the profits of a corporation even before they are divided, and much less to tax a certificate of stock issued to represent such profits. (2) The most that can be said of the opinion is that it holds that the term "dividend” in its ordinary acceptation does not include stock dividends, and that since the Act of 1913 used the term "dividend” without qualification stock dividends were not taxable under it. Gibbons v. Mahon, 136 U. S. 549, 559, 560. (3) The Actof 1916, however, expressly taxes stock dividends, and hence Towne v. Eisner is not controlling.
The case of Lynch v. Hornby, 247 U. S. 339, holding that cash dividends are to be treated as income for the year in which received, whether paid out of earnings accruing before or after March 1,1913, in view of the reasons stated for the holding, would not have been inconsistent with a holding that stock dividends were taxable when representing earnings accruing after March 1, 1913, but not taxable when representing earnings accruing béfore that, date.
But whether such holdings would have been inconsistent or not, the holding in Lynch v. Hornby is not controlling in this case, since the Act of 1916 makes it plain that dividends, whether paid in cash or stock, are to be taxed only when they represent earnings accruing after March 1, 1913.
While Gibbons v. Mahon, supra, holds that as between a life tenant and a remainderman stock dividends are not income, that case arose in the District of Columbia, , involves no federal question, and is not controlling in similar cases arising in the state courts. As a matter of fact, most of the state courts have adopted a different ruling and hold that stock dividends are income. In the Act of 1916, therefore, Congress was clearly within its power when it declared that by “dividends” it meant either cash or stock dividends in accordance with the meaning of the term as understood and construed by the courts of most of the States. Pritchitt v. Nashville Trust Co., 96 Tennessee, 472; Thomas v. Gregg, 78 Maryland, 545; McLouth v. Hunt, 154 N. Y. 179; Will of Pabst, 146 Wisconsin, 330; Lord v. Brooks, 52 N. H. 72; Hite v. Hite, 93 Kentucky, 257; Moss’s Appeal, 83 Pa. St. 264; Paris v. Paris, 10 Ves. Jr. 184; Tax Commissioner v. Putnam, 227 Massachusetts, 522; Matter of Osborne, 209 N. Y. 450; Goodwin v. McGaughey, 108 Minnesota, 248.
The ultimate object of corporate business is gain to the stockholders. This gain always and necessarily first ap pears in the shape of undivided profits which are held in trust for them. When, later, dividends are declared, the cash or stock received by a stockholder is the same gain converted into a concrete form for the convenient payment, transfer, or definite assignment to him of his share of the previously undivided profits.
The Government is under no delusions as to the nature of a stock dividend, or as to what it accomplishes. It serves to readjust the evidence of ownership by which the stockholder previously held his share of both capital and undivided profits. His share of profits is invested for him in the stock of the company. The profits are segregated from his former capital and he has a separate certificate representing his invested profits or gains. It is, of course, conceded that this transaction does not, of itself, make the stockholder richer than he was before. The Government readily agrees that there has been a mere change in form of that which already belonged to the stockholder and that what was not income before is not income after a stock dividend. But this contention of defendant in error proves too much and destroys her case. Her share of undivided profits which has, by undergoing a mere change of form, become 198 shares of stock, was itself income within the'power of Congress to tax. Unless its change of form destroyed its previous character it was still income. It is defendant in error and not the Government who must rely upon the change of form for success in this case. The Government claims the right to tax gains when wearing a new dress only when they were taxable in their old dress. The defendant in error’s contention cannot succeed unless the new dress destroys the power to tax which existed before it was put on.
So far as what they serve to transfer or assign to stockholders is concerned, there are but two points of difference between cash dividénds and stock dividends. By a cash dividend, a corporation transfers to a stockholder his share of corporate earnings in money, while, in the case of a stqck dividend, it first invests the earnings in its business and then issues to each stockholder new shares of stock of the same par value as his share of the earnings or, to use other words, invests each stockholder’s share of the earnings in its own stock at par and delivers to him the stock so purchased. In either case, he simply gets, in a concrete form, the actual gains he has derived from his invested capital.
The other point of difference is that a cash dividend may serve either to distribute profits or return capital. A stock dividend, on the other hand, never contemplates a reduction in capital but, on the contrary, necessarily implies an increase in capital to be represented by the new shares. It can never, therefore, serve to retilrn capital, but that which, in the form of new stock, it assigns to each stockholder, is always a share of corporate earnings or gains. In other words, a cash dividend may or may not distribute gains, but a stock dividend cannot, under any circumstances, distribute, assign, or transfer anything else.
If the constitutional power exists to tax corporate earnings when they are passed to the stockholder by means of a cash dividend, no reason is perceived why the same power does not exist to tax the same earnings when they are passed to him, in an equally concrete form, by means of a stock dividend.
Stock issued as a dividend is property in every sense that any other thing of value is property.
The Act of 1916 taxes gains derived from capital invested in corporate stocks, that is, shares of corporate gains or profits. It does not tax dividends per se but merely uses them to indicate the form in which such gains shall be taxed and to mark the time when the tax shall be collected. And, in the case of stock dividends, it uses the stock issued to measure the amount of the gains.
The substance of the Act of 1916 is that no corporate earnings are taxed as distributed gains which might not have been taxed as undivided profits when they accrued, and all such éarnings which might have been taxed as undivided profits are taxed when distributed.
Before a dividend, one certificate is the evidence oí a stockholder’s ownership of a share of capital and also a share of profits. When he receives a cash dividend the value of his certificate is reduced and the money received measures the gain which his investment ñas yielded. When he receives a stock dividend, the par value of his new certificate measures his gains. As the fruit or result of his investment, something of value, which is distinct from his original capital and distinct from the corporation’s ownership' of its assets', has come to him.
The fact that a stockholder is no richer immediately after than immediately before a stock dividend is wholly unimportant. Neither is he made richer by a cash dividend.
The important fact is that, assuming the profits have been earned since March 1, 1913, he has, in either case, become richer since that date through the earnings of his invested capital. Congress has seen fit to say that these earnings may accumulate free from tax until they are delivered to him either as cash or in stock. His gain comes, not from the declaration of a dividend of any kind, but from what his capital has earned. The only effect of the dividend is to fix the date upon which, under the law, his share of corporate earnings, previously accrued, becomes taxable.
Mr. Charles E. Hughes, with whom. Mr. George Welwood Murray was on the briefs, for defendant in error:
The tax in question is not laid with respect to the taxpayer’s interest in undivided corporate profits as constituting income to the taxpayer, or upon the “stock dividend” as the form or dress in which a previous gain or income to the taxpayer appears. The tax is laid upon the “stock dividend” as constituting income in itself.
Undivided corporate profits are not income to the stockholder. It is of the essence of income that it should be realized. Potentiality is not enough. Book entries or opinions of increase are not income. Income necessarily implies separation and realization. The increase of the forest is not income until it is cut. The increase in the value of lands due to the growth and prosperity of the community is not income until it is realized. Where investments are concerned, there is no income until there has been a separate, realized gain. When a corporation earns profits, it receives money over the amount of its expenditures. The money belongs to the corporation; the profits are the property of the corporation. If the corporation distributes its earnings in dividends, properly so-called, that is, in money, or in property in specie, the stockholder has realized a gain and that gain is income. The shareholder has simply his share, his interest, in the corporate enterprise. The corporation must, of course, pay its income tax upon its profits, but there is no' income to the shareholder unless he receives it. His share interest is a “capital” interest.
•This distinction is not a form or technicality. It is a vital distinction inherent in corporate organization. The interest of the shareholder is a distinct interest. The profits of the corporation are not his profits. This distinction between the title of a corporation and the interest of its shareholders in the property of the corporation, including its earnings, has been authoritatively established by two lines of decisions of this court in cases involving •the power of taxation:
(1) Van Allen v. The Assessors, 3 Wall. 573, 584; People v. Commissioners, 4 Wall. 244; Bradley v. People, 4 Wall. 459; National Bank v. Commonwealth, 9 Wall. 353, 358, 359; Owensboro National Bank v. Owensboro, 173 U. S. 664, 680; Evansville Bank v. Britton, 105 U. S. 322; Cleveland Trust Co. v. Lander, 184 U. S. 111; Home Savings Bank v. Des Moines, 205 U. S. 503; Rogers v. Hennepin County, 240 U. S. 184.
(2) Bank of Commerce v. Tennessee, 161 U. S. 134, 146; Shelby County v. Union & Planters’ Bank, 161 U. S. 149, 153-154; Wright v. Georgia R. R. & Banking Co., 216 U. S. 420, 425; Farrington v. Tennessee, 95 U. S. 679; Sturges v. Carter, 114 U. S. 511; Tennessee v. Whitworth, 117 U. S. 129; New Orleans v. Houston, 119 U. S. 265; New Orleans v. Citizens’ Bank, 167 U. S. 371; Powers v. Detroit, Grand Haven &c. Ry. Co., 201 U. S. 543.
When the question of the nature of the shareholder’s interest in undivided profits came before this court in Gibbons v. Mahon, 136 U. S. 549, the question was carefully considered and explicitly determined. The court pointed out the distinction between the money earned by the corporation and the shareholder’s income, and ruled expressly that the interest of the shareholder in the accumulated earnings of the corporation, as a part of his share interest, was capital and not income, so long as the earnings were held and invested by the corporation as a part of its corporate property. See Towne v. Eisner, 245 U. S. 418.
The case of Collector v. Hubbard, 12 Wall. 1, arose under a provision that gains and profits of certain companies should be included in estimating the annual gains, profits or income of any person entitled to the same, whether divided or otherwise. The object was to insure the payment of the tax upon the earnings of the corporation (see Gibbons v. Mahon, 136 U. S. 549, 560). It was a crude method of reaching the corporate earnings and was the only tax imposed with respect to those earnings. A shareholder was to be taxed upon the increment supposed to have been added to the value of his share by his pro portionate interest in the undivided profits. This, as a matter of statutory construction, is clear enough. But it by no means, follows that this increment was income to the shareholder, when it becomes necessary to distinguish between a tax on income and a direct tax on the capital investment.
The Hubbard Case was dealing with the mere, fact of the increment and did not deal with its nature, as the court in the Gibbons Case was called upon to deal. The reason why the court in the Hubbard Case was not called upon to define the nature of the increment, beyond the fact that it was property, is apparent from the absence of any controversy over a constitutional question, and from the opinion entertained at the time with respect to what was a direct and what was an indirect tax under the Federal Constitution; accepting the view then entertained of direct and indirect taxes, the decision was unassailable.
It was not necessary for Mr. Justice Clifford, in the absence of the debate which about twenty-five years later took place in Pollock v. Farmers’ Loan & Trust Co., 157 U. S. 429; 158 U. S. 601, to go further. When, however, the court had occasion to deal with the precise question, in Gibbons v. Mahon, it stated its conclusion emphatically, and without the slightest reservation, that whatever increment there was, through undivided profits held and invested by the corporation, to the share of the stockholder, was capital and not income. But the increment in the Hubbard Case was nothing but an accretion to capital. It was not a separated, realized gain. It was not income. Hence, under the doctrine of the Pollock Case and the doctrine now applicable to all cases where a capital interest is taxed, the tax could not validly be laid except as an apportioned direct tax. [Bailey v. Railroad Co., 22 Wall. 604, and recent cases cited by the Government, distinguished.]
Income is the gain, come to fruition, from capital, from labor, or from both combined. This is sound doctrine both in law and in economics. Income of a corporation is not income of a shareholder until distributed. A “ stock dividend” is not income. It does not constitute a distribution of anything; it is a mere readjustment of capital. Stratton’s Independence v. Howbert, 231 U. S. 399, 415; Doyle v. Mitchell Bros. Co., 247 U. S. 179, 185; Lynch v. Hornby, 247 U. S. 339, 343; Lynch v. Turrish, 247 U. S. 221, 231; Commissioners of Inland Revenue v. Blott [reported in the London Times of July 25, 1919]; Seligman, Income Tax, p. 19; “The Economic Nature of the Stock Dividend,” by Fairchild, Bulletin of National Tax Assn., vol. III, No. 7, April, 1918, p. 163; Seligman, “Are Stock Dividends Income,” American Economic Review, vol. IX, No. 3, p. 517; Peabody v. Eisner, 247 U. S. 347; Towne v. Eisner, 245 U. S. 418, 426; Union Trust Co. v. Coleman, 126 N. Y. 433, 438.
The tax in question is an income tax and cannot be sustained as anything else.
Mr. George W. Wicker sham and Mr: Charles Robinson Smith, by leave of court, filed a brief as amici cwrice:
The principle laid down by this court in two well-considered cases (Gibbons v. Mahon, 136 U. S. 549, and Towne v. Eisner, 245 U. S. 418), that stock dividends represent capital and do not constitute income is based on sound economic reasoning.
Although Collector v. Hubbard, 12 Wall. 1, is plainly distinguishable from the case at bar, it is inconsistent both with other and later rulings of this court and with sound economics. It tends to block the way to a consistent, harmonious and logical system of income taxation and it should be expressly overruled. As upholding a tax on property except by apportionment under Art. I, § 2, of the Constitution, it has been overruled by Pollock v. Farmers’ Loan & Trust Co., 157 U. S. 429; 158 U. S. 601. In so far as it assumes an equivalency between the property and the income of the corporation and the shares of stock in the names of the stockholders for taxation purposes, it has been implicitly overruled by a long series of authorities in this court. The suggestion that this court has in other cases cited Collector v. Hubbard or its principle with approval except upon altogether minor points is erroneous.
The stock dividend is in reality not a dividend at all. It is a mere certified expression of an undivided surplus and its capitalization. Whatsoever gain there may be in either case to the stockholder is a capital gain. Capital gains (being mere increases in valuation) are not income until realized. The gains that come with stock dividends when stock is sold are realized capital gains — the same in. nature and similarly taxable as those gains that are made with any stock that is sold at an advance. Inasmuch as undivided corporate earnings cannot be taxed as income against the stockholder — so the stock certificates issued merely to represent these may not be so taxed, until the gain be realized in some form by sale.

Opinion:
Mr. Justice Pitney
delivered the opinion of the court.
This case presents the question whether, by virtue of the Sixteenth Amendment, Congress has the power to tax, as income of the stockholder and without apportionment, a stock dividend made lawfully and in good faith against profits accumulated by the corporation since March 1, 1913.
It arises under the Revenue Act of September 8, 1916, c. 463, 39 Stat. 756, et seq., which, in our opinion (notwithstanding a contention of the Government that will be noticed), plainly evinces the purpose of Congress to tax stock dividends as income.
The facts, in outline, are as follows:
On January 1, 1916, the Standard Oil Company of California, a corporation of that State, out of an authorized capital stock of $100,000,000, had shares of. stock outstanding, par value $100 each, amounting in round figures to $50,000,000. In addition, it had surplus and undivided profits invested in plant, property, and business and required for the purposes of the corporation, amounting to about $45,000,000, of which about $20,000,000 had been earned prior to March 1,1913, the balance thereafter. In January, 1916, in order to readjust the capitalization, the board of directors decided to issue additional shares sufficient to constitute a stock dividend of 50 per cent, of the outstanding stock, and to transfer from surplus account to capital stock account an amount equivalent to such -issue. Appropriate resolutions were adopted, an amount equivalent to the par value of the proposed new stock was transferred accordingly, and the new stock duly issued against it and divided among the stockholders.
Defendant in error, being the owner of 2,200 shares of the old stock, received certificates for 1,100 additional shares, of which 18.07 per cent., or 198.77 shares, par value $19,877, were treated as representing surplus earned between March 1, 1913, and January 1, 1916. She was called upon to pay, and did pay under protest, a tax imposed under the Revenue Act of 1916, based upon a supposed income of $19,877 because of the new shares; and an appeal to the Commissioner of Internal Revenue having been disallowed, she brought action against the Collector to recover the tax. In her complaint she alleged the above facts, and contended that in imposing such a tax the Revenue Act of 1916 violated Art. I, § 2, cl. 3, and Art. I, § 9, cl. 4, of the Constitution of the United States, requiring direct taxes to be apportioned according to population, and that the stock dividend was not income within the meaning of the Sixteenth Amendment. A general demurrer to the complaint was overruled upon the authority of Towne v. Eisner, 245 U. S. 418; and, defendant having failed to plead further, final judgment went against him. To review it, the present' writ of error is prosecuted.
The case was argued at the last term, and reargued at the present term, both orally and by additional briefs.
We are constrained to hold that the judgment of the District Court must be affirmed: First, because the question at issue is controlled by Towne v. Eisner, supra; secondly, because a reexamination of the question, with the additional light thrown upon it by elaborate arguments, has confirmed the view that the underlying ground of that decision is sound, that it disposes of the question here presented, and that other fundamental considerations lead to the same result.
In Towne v. Eisner; the question was whether a stock dividend made in 1914 against surplus earned prior to January 1,1913, was taxable against the stockholder under the Act of October 3, 1913, c. 16, 38 Stat. 114, 166, which provided (§ B, p. 167) that net income should include "dividends," and also "gains or profits and income de rived, from any source whatever." Suit having been brought by a stockholder to recover the tax assessed against him by reason of the dividend, the District Court sustained a demurrer to the complaint. 242 Fed. Rep. 702. The court treated the construction of the act as inseparable from the interpretation of the Sixteenth Amendment; and, having referred to Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, and quoted the Amendment, proceeded very properly to say (p. 704): "It is manifest that the stock dividend in question cannot be reached by the Income Tax Act, and could not, even though Congress expressly declared it to be taxable as income, unless it is in fact income." It declined, however, to accede to the contention that in Gibbons v. Mahon, 136 U. S. 549, "stock dividends" had received a definition sufficiently clear to be controlling, treated the language of this court in that case as obiter dictum in respect of the matter then before it (p. 706), and examined the question as res nova, with the result stated. When the case came here, after overrulling a motion to dismiss made by the Government upon the ground that the only question involved was the construction of the statute and not its constitutionality, we dealt upon the merits with the question of construction only, but disposed of it upon consideration of the essential nature of a stock dividend, disregarding the fact that the one in question was based upon surplus earnings that accrued before the Sixteenth Amendment took effect. Not only so, but we rejected the reasoning of the District Court, saying (245 U. S. 426): "Notwithstanding the thoughtful discussion that the case received below we cannot doubt that the dividend was capital as well for the purposes of the Income Tax Law as for distribution between tenant for life and remainderman. What was said by this court upon the latter question is equally true for the former. 'A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders. Its property is not diminished, and their interests are not increased. . . . The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones.' Gibbons v. Mahon, 136 U. S. 549, 559, 560. In short, the corporation is no poorer and the stockholder is no richer than they were before. Logan County v. United States, 169 U. S. 255, 261. If the plaintiff gained any small advantage by the change, it certainly was not an advantage of $417,450, the sum upon which he was taxed. . . . What has happened is that the plaintiff's old certificates have been split up in effect and have diminished in value to the extent of the value of the new."
This language aptly answered not- only the reasoning of the District Court but the argument of the Solicitor General in this court, which discussed the essential nature of a stock dividend. And if, for the reasons thus expressed, such a dividend is not to be regarded as "income" or "dividends" within the meaning of the Act of 1913, we are unable to see how it can be brought within the meaning of "incomes" in the Sixteenth Amendment; it being very clear that Congress intended in that act to exert its power to the., extent permitted by the Amendment. In Towne v. Eisner it was not contended that any construction of the statute could make itaiarrower than the constitutional grant; rather the contrary.
The fact that the. dividend was charged against profits earned before the Act of 1913 took effect, even-before the Amendment was adopted, was neither relied upon nor alluded to in our consideration of the merits in that case. Not only so, but had we considered that a stock dividend constituted income in any true sense, it would have been held taxable under the Act of 1913 notwithstanding it was based upon profits earned before the Amendment. We ruled at the same term, in Lynch v. Hornby, 247 U. S. 339, that a cash dividend extraordinary in amount, and in Peabody v. Eisner, 247 U. S. 347, that a dividend paid in stock of another company, were taxable as income although based upon earnings that accrued before adoption of the Amendment. In the former case, concerning "corporate profits that accumulated before the Act took effect," we declared (pp. 343-344): "Just as we deem the legislative intent manifest to tax the stockholder with respect to such accumulations only if and when, and to the extent that, his interest in them comes to fruition as income, that is, in dividends declared, so we can perceive no constitutional obstacle that stands in the way of carrying out this intent when dividends are declared out of a preexisting surplus. . . . Congress was at liberty under the Amendment to tax as income, without apportionment, everything that became income, in the ordinary sense of the word, after the adoption of the Amendment, including dividends received in the ordinary course by a stockholder from a corporation, even though they were extraordinary in amount and might appear upon analysis to be a mere realization in possession of an inchoate and contingent interest that the stockholder hád in a surplus of corporate assets previously existing." In Peabody v. Eisner (pp. 349-350), we observed that the decision of the District Court in Towne v. Eisner had been reversed "only upon the ground that it related to a stock dividend which in fact took nothing from the property of the corporation and added nothing to the interest of the shareholder, but merely changed the evidence which represented that interest;" and we distinguished the.Peabody Case from the Towne Case upon the ground that "the dividend of Baltimore & Ohio shares was not a stock dividend but a distribution in specie of a portion of the assets of the Union Pacific."
Therefore, Towne v. Eisner cannot be regarded as tum ing upon the point that the surplus accrued to the company before the act took effect and before adoption of the Amendment. And what we have quoted from the opinion in that case cannot be regarded as obiter dictum, it having furnished the entire basis for the conclusion reached. We adhere to the view then expressed, and might rest the present case there; not because that case in terms decided the constitutional question, for it did not; but because the conclusion there reached as to the essential nature of a stock dividend necessarily prevents its being regarded as income in any true sense.
Nevertheless, in view, of the importance of the matter, and the fact that Congress in the Revenue Act of 1916 declared (39 Stat. 757) that a "stock dividend shall be considered income, to the amount of its cash value," we will deal at length with the constitutional question, incidentally testing the soundness of our previous conclusion.
The Sixteenth Amendment must be construed in connection with the taxing clauses of the original Constitution and the effect attributed to them before the Amendment was adopted. In Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, under the Act of August 27, 1894, c. 349, § 27, 28 Stat. 509, 553, it was held that taxes upon rents and profits of real estate and upon returns from investments of personal propérty were in effect direct taxes upon the property from which such income arose, imposed by reason of ownership; and that Congress could not in pose such taxes without apportioning them among the States according to population, as required by Art. I, § 2, cl. 3, and § 9, cl. 4, of the original Constitution.
Afterwards, and evidently in recognition of the limitation upon the taxing power of Congress thus determined, the Sixteenth Amendment was adopted, in words lucidly expressing the object to be accomplished: "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration." As repeatedly held, this did not extend the taxing power to new subjects, but merely removed the necessity which otherwise might exist for an apportionment among the States of taxes laid on income. Brushaber v. Union Pacific R. R. Co., 240 U. S. 1, 17-19; Stanton v. Baltic Mining Co., 240 U. S. 103, 112 et seq.; Peck & Co. v. Lowe, 247 U. S. 165, 172-173.
A proper regard for its genesis, as well as its very clear language, requires also that this Amendment shall not be extended by loose construction, so as to repeal or modify, except as applied to income, those provisions of the Constitution that require an apportionment according to population for direct taxes upon property, real and personal. This limitation still has an appropriate and important function, and is not to be overridden by Congress or disregarded by the courts.
In order, therefore, that the clauses cited from Article I of the Constitution may have proper force and effect, save only as modified by the Amendment, and that the latter also may have proper effect, it becomes essential to distinguish between what is and what is not "income," as the term is there used; and to apply the distinction, as cases arise, according to truth and substance, without regard to form. Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised.
The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. For the present purpose we require only a clear definition of the term "in come," §ts used in common speech, in order to determine its 'meaning in the Amendment; and, having formed also a correct judgment as to the nature of a stock dividend, we. shall find it easy to decide the matter at issue.
After examining dictionaries in common use (Bouv. L. D.; Standard Dict.; Webster's Internat. Dict.; Century Dict.), we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909 (Stratton's Independence v. Howbert, 231 U. S. 399, 415; Doyle v. Mitchell Bros. Co., 247 U. S. 179, 185)— "Income may be defined as the gain derived from capital, from labor, or from both combined," provided it be understood to include profit gained through a sale or conversion of capital assets, to which it was applied in the Doyle Case (pp. 183, 185).
Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The Government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word "gain," which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. ' ' Derived — from—capital ' '; — ' ' the gain— derived — from—capital," etc. Here we have the essential matter: not a gain accruing to capital, not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, severed from the capital however invested or employed, and coming in, being " derived," that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; — that is income derived from property. Nothing else answers the description.
The same fundamental conception is clearly set forth in the Sixteenth Amendment — "incomes, from whatever source derived" — the essential thought being expressed with a conciseness and lucidity entirely in harmony with the form and style of the Constitution.
Can a stock dividend, considering its essential character, be brought within the definition? To answer this, regard must be had to the nature of a corporation and the stockholder's relation to it. We refer, of course, to a corporation such as the one in the case at bar, organized for profit, and having a capital stock divided into shares to which a nominal or par value is attributed.
• Certainly the interest of the stockholder is a capital interest, and his certificates of stock are but the evidence of it. They state the number of shares to which he is entitled and indicate their par value and how the stock may be transferred. They show that he or his assignors, immediate or remote, have contributed capital to the enterprise, that he is entitled to a corresponding interest proportionate to the whole, entitled to have the property and business of the company devoted during the corporate existence to attainment of the common objects, entitled to vote at stockholders' meetings, to receive dividends out of the corporation's profits if and when declared, and, in the event of liquidation, to receive a proportionate share of the net assets, if any, remaining after paying creditors. Short of liquidation, or until dividend declared, he has no right to withdraw any part of either capital or profits from the common enterprise; on the contrary, his interest pertains not to any part, divisible or indivisible, but to the entire assets, business, and affairs of the company. Nor is it the interest of an owner in the assets themselves, since the corporation has full title, legal and equitable, to the whole. The stockholder has the right to have the assets employed in the enterprise, with the incidental rights mentioned; but, as stockholder, he has no 'right to withdraw, only the right to persist, subject to the risks of the enterprise, and looking only to dividends for his return. If he desires to dissociate himself from the company he can do so only by disposing of his stock.
For bookkeeping purposes, the company acknowledges a liability in form to the stockholders equivalent to the aggregate par value of their stock, evidenced by a "capital stock account." If profits have been made and not divided they create additional bookkeeping liabilities under the head of "profit and loss," "undivided profits," "surplus account," or the like. None of these, however, gives to the stockholders as a body, much less to any one of them, either a claim against the going concern for any particular sum of money, or a right to any particular portion of the assets or any share in them unless or until the directors conclude that dividends shall be made and a part of the company's assets segregated from the common fund for the purpose. The dividend normally is payable in money, under exceptional circumstances in some other divisible property; and when so paid, then only (excluding, of course, a possible advantageous sale of his stock or winding-up of the company) does the stockholder realize a profit or gain which becomes his separate property, and thus derive income from the capital that he or his predecessor has invested.
In the present case, the corporation had surplus and undivided profits invested in plant, property, and business, and required for the purposes of the corporation, amounting to about $45,000,000, in addition to outstanding capital stock of $50,000,000. In this the case is not extraordinary. The profits of a corporation, as they appear upon the balance sheet at the end of the year, need not be* in the form of money on hand in excess of what is required to meet current liabilities and finance current operations of the company. Often, especially in a growing business, only a part, sometimes a small part, of the year's profits is in property capable of division; the remainder having been absorbed in the acquisition of increased plant, equipment, stock in trade, or accounts receivable, or in decrease of outstanding liabilities. When only a part is available for dividends, the balance of the year's profits is carried to the credit of undivided profits, or surplus, or some other account having like significance. If thereafter the .company finds itself in funds beyond current needs it may declare dividends out of such surplus or undivided profits; otherwise it may go on for years conducting a successful business, but requiring more and more working capital because of the extension of its operations, and therefore unable to declare dividends approximating the amount of its profits. Thus the surplus may increase until it equals or even exceeds the par value of the outstanding capital stock. This may be adjusted upon the books in the mode adopted in the case at bar — by declaring a "stock dividend." This, however, is no more than a book adjustment, in essence not a dividend but rather the opposite; no part of the assets of the company is separated from the common fund, nothing distributed except paper certificates that evidence an antecedent increase in the value of the stockholder's capital interest resulting from an accumulation of profits by the company, but profits so far absorbed in the business as to render it impracticable to separate them for withdrawal and distribution. In order to make the adjustment, a charge is made against surplus account with corresponding credit to capital stock account, equal to the proposed "dividend"; the new stock is issued against this and the certificates delivered to the existing stockholders in proportion to their previous holdings. This, however, is merely bookkeeping that does not affect the aggregate assets of the corporation or its outstanding liabilities; it affects only the form, not the essence, of the "liability" acknowledged by the corporation to its own shareholders, and this through a readjustment of accounts on one side of the balance sheet only, increasing "capital stock" at the expense of "surplus";.it does not alter the preexisting proportionate interest pf any stockholder or increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they stood before. The new certificates simply increase the number of the shares, with consequent dilution of the value of each share.
A "stock dividend" shows that the company's accumulated profits have been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution in money or in kind should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone such realization, in that the fund represented by the new stock has been transferred from surplus to capital, and no longer is available for actual distribution.
The essential and controlling fact is that the stockholder has received nothing out of the company's assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations have résulted from employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance and not to form, he has received nothing that answers the definition of income within the meaning of the Sixteenth Amendment.
Being concerned only with the true character and effect of such a dividend when lawfully made, we lay aside the question whether in a particular case a stock dividend may be authorized by the local law governing the corporation, or whether the capitalization of profits may be the result of correct judgment and proper business policy on the part of its management, and a due regard for the interests of the stockholders. And we are considering the taxability of bona fide stock dividends only.
We are clear that not only does a stock dividend really take nothing from the property of the corporation and add nothing to that of the shareholder, but that the antecedent accumulation of profits evidenced thereby, while indicating that the shareholder is the richer because of an increase of his capital, at the same time shows he has not realized or received any income in the transaction.
It is said that a stockholder may sell the new shares acquired in the stock dividend; and so he may, if he can find a buyer. It is equally true that if he does sell, and in doing so realizes a profit, such profit, like any other, is income, and so far as it may have arisen since the Sixteenth Amendment is taxable by Congress without apportionment. The same would be true were he to sell some of his original shares at a profit. But if a shareholder sells dividend stock he necessarily disposes of a part of his capital interest, just as if he should sell a part of his old stock, either before or after the dividend. What he retains no longer entitles him to the same proportion of future dividends as before the sale. His part in the control of the company likewise is diminished. Thus, if one holding $60,000 out of a total $100,000 of the capital stock of a corporation should receive in common with other stockholders a 50 per cent, stock dividend, and should sell his part, he thereby would be reduced from a majority to a minority stockholder, having six-fifteenths instead of six-tenths of the total stock outstanding. A corresponding and proportionate decrease in capital interest and in voting power would befall a minority holder should he sell dividend stock; it being in the nature of things impossible for one to dispose of any part, of such an issue without a proportionate disturbance of the distribution of the entire capital stock, and a like diminution of the seller's comparative voting power — that "right preservative of rights" in the control of a corporation. Yet, without selling, the shareholder, unless possessed of other resources, has not the wherewithal to pay an income tax upon the dividend stock. Nothing could more clearly show that to tax a stock dividend is to tax a capital increase, and not income, than this demonstration that in the nature of things it requires conversion of capital in order to pay the tax.
Throughout the argument of the Government, in a variety of forms, runs the fundamental error already mentioned — a failure to appraise correctly the force of the term "income" as used in the Sixteenth Amendment, or at least to give practical effect to it. Thus, the Government contends that the tax "is levied on income derived from corporate earnings," when in truth the stockholder has "derived" nothing except paper certificates which, so far as they have any effect, deny him present participation in such earnings. It contends that the tax may be laid when earnings "are received by the stockholder," whereas he has received none; that the profits are "distributed by means of a stock dividend," although a stock dividend distributes no profits; that under the Act of 1916 "the tax is on the stockholder's share in corporate earnings," when in truth a stockholder has no such share, and receives none in a stock dividend; that "the profits are segregated from his former capital, and he has a separate certificate representing his invested profits or gains," whereas there has been no segregation of profits, nor has he any separate certificate representing a personal gain, since the certificates, new and old, are alike in what they represent — a capital interest in the entire concerns of the corporation.
We have no doubt of the power or duty of a court to look through the form of the corporation and determine the question of the stockholder's right, in order to ascertain whether he has received income taxable by Congress without apportionment. But, looking through the form, we cannot disregard the essential truth disclosed; ignore the substantial difference between corporation and stockholder; treat the entire organization as unreal; look upon stockholders as partners, when they are not such; treat them as having in equity a right to a partition of the corporate assets, when they have none; and indulge the fiction that they have received and realized a share of the profits of the company which in truth they have neither received nor realized. We must treat the corporation as a substantial entity separate from the stockholder, not only because such is the practical fact but because it is only by recognizing such separateness that any dividend — even one paid in money or property — -can be regarded as income of the stockholder. Did we regard corporation and stockholders as altogether identical, there would be no income except as the corporation acquired it; and while this would be taxable against the corporation as income under appropriate provisions of law, the individual stockholders could not be separately and additionally taxed with respect to their several shares even when divided, since if there were entire identity between them and the company they could not be regarded as receiving anything from it, any more than if one's money were to be removed from one pocket to another.
Conceding that the mere issue of a stock dividend makes the recipient no richer than before, the Government nevertheless contends that the new certificates measure the extent to which the gains accumulated by the corporation have made him the richer. There are two insuperable difficulties with this: In the first place, it would depend upon how long he had held the stock whether the stock dividend indicated the extent to which he had been enriched by the operations of the company; unless he had held it throughout such operations the measure would not hold true. Secondly, and more important for present purposes, enrichment through increase in value of capital investment is not income in any proper meaning of the term.
The complaint contains averments respecting the market prices of stock such as plaintiff held, based upon sales before and after the stock dividend, tending to show that the receipt of the additional shares did not substantially change the market value of her entire holdings. This tends to . show that in this instance market quotations reflected intrinsic values — a thing they do not always do. But we regard the market prices of the securities as an unsafe criterion in an inquiry such as the present, when the question must be, not what will the thing sell for, but what is.it in truth and in essence.
It is said there is no difference in principle between a simple stock dividend and a case where stockholders use money received as cash dividends to purchase additional stock contemporaneously issued by the corporation. But an actual cash dividend, with a real option to the stockholder either to keep the money for his own or to reinvest it in new shares, would be as far removed as possible from a true stock dividend, such as the one we have under consideration, where nothing of value is taken from the company's assets and transferred to the individual ownership of the several stockholders and thereby subjected to their disposal.
The Government's reliance upon the supposed analogy between a dividend of the corporation's own shares and one made by distributing shares owned by it in the stock of another company, calls for no comment beyond the statement that the latter distributes assets of the company among the shareholders while the former does not; and for no citation of authority except Peabody v. Eisner, 247 U. S. 347, 349-350.
Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of the position of the Government.
Swan Brewery Co., Ltd., v. Rex, [1914] A. C. 231, arose under the Dividend Duties Act of Western Australia, which provided that "dividend" should include "every dividend, profit, advantage, or gain intended to be paid or credited to or distributed among any members or directors of any company," except, etc. There was a stock dividend, the new shares being allotted among the shareholders pro rata; and the question was whether this was a distribution of a dividend within the meaning of the act. The Judicial Committee of the Privy Council sustained the dividend duty upon the ground that, although "in ordinary language the new shares would not be called a dividend, nor would the allotment of them be a distribution of a dividend," yet, within the meaning of the act, such new shares were an 1 ' advantage " to the recipients. There being no constitutional restriction upon the action of the lawmaking body, the case presented merely a question of statutory construction, and manifestly the decision is not a precedent for the guidance of this court when acting under a duty to test an act of Congress by the limitations of a written Constitution having superior force.
In Tax Commissioner v. Putnam (1917), 227 Massachusetts, 522, it was held that the 44th Amendment to the constitution of Massachusetts, which conferred upon the legislature full power to tax incomes, "must be interpreted as including every item which by any reasonable understanding can fairly be regarded as income" (pp. 526, 531); and that under it a stock dividend was taxable as income, the court saying (p. 535): "In essence the thing which has been done is to distribute a symbol representing an accumulation of profits, which instead of being paid out in cash is invested in the business, thus augmenting its durable assets. In this aspect of the case the substance of the transaction is no different from what it would be if a cash dividend had been declared with the privilege of subscription to an equivalent amount of new shares." We cannot accept this reasoning. Evidently, in order to give a sufficiently broad sweep to the new taxing provision, it was deemed necessary to take the symbol for the substance, accumulation for distribution, capital accretion for its opposite; while a case where money is paid into the hand of the stockholder with an option to buy new shares with it, followed -by acceptance of the option, was regarded as identical in substance with a case where the stockholder receives no money and has no option. The Massachusetts court was not under an obligation, like the one which binds us, of applying a constitutional amendment in the light of other constitutional provisions that stand in the way of extending it by construction.
Upon the second argument, the Government, recognizing the force of the decision in Towne v. Eisner, supra, and virtually abandoning the contention that a stock dividend increases thé interest of the stockholder or otherwise enriches him, insisted as an alternative that by the true construction of the Act of 1916 the tax is imposed not upon the stock dividend but rather upon the stockholder's share of the undivided profits previously accumulated by-the corporation; the tax being levied as a matter of convenience at the time such profits become manifest through the stock dividend. If so construed, would the act be constitutional?
That Congress has power to tax shareholders - upon their property interests in the stock of corporations is beyond question; and that such interests might be valued in view of the condition of the company, including its accumulated and undivided profits,, is equally clear. But that this would be taxation of property because of ownership, and hence would require apportionment under the provisions of the Constitution, is settled beyond peradventure by previous decisions of this court.
The Government relies upon Collector v. Hubbard (1870), 12 Wall. 1, 17, which arose under § 117 of the Act of June 30, 1864, c. 173, 13 Stat. 223, 282, providing that "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." The court held an individual taxable upon his proportion of the earnings of a corporation although not declared as dividends and although invested in assets not in their nature divisible. Conceding that the stockholder for certain purposes had no title prior to dividend declared, the court nevertheless said (p. 18): "Grant all that, still it is true that the owner of a share of stock in a corporation holds the share with all its incidents, and that among those incidents is the right to receive all future dividends, that is, his proportional share of all profits not then divided. Profits are incident to the share to which the owner at once becomes entitled provided he remains a member of. the corporation until a dividend is made. Regarded as an incident to the shares, undivided profits are property of the shareholder, and as such are the proper subject of sale, gift, or devise. Undivided profits invested in real estate, machinery, or raw material for the purpose of being manufactured are investments in which the stockholders are interested, and when such profits are actually appropriated to the payment of the debts of the corporation they serve to increase the market value of the shares, whether held by the original subscribers or by assignees." In so far as this seems to uphold the right of Congress to tax without apportionment a stockholder's interest in accumulated earnings prior to dividend declared, it must be regarded as overruled by Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, 627, 628, 637. Conceding Collector v. Hubbard was inconsistent with the doctrine of that case, because it sustained a direct tax upon property not apportioned among the States, the Government nevertheless insists that the Sixteenth Amendment removed this obstacle, so that now the Hubbard Case is authority for the power of Congress to levy a tax on the stockholder's share in the accumulated profits of the corporation even before division by the declaration of a dividend of any kind. Manifestly this argument must be rejected, since the Amendment applies to income only, and what is called the stockholder's share in the accumulated profits of the company is capital, not income. As we have pointed out, a stockholder has no individual share in accumulated profits, nor in any particular part of the assets of the corporation, prior to dividend declared.
Thus, from every point of view, we are brought irresistibly to the conclusion that neither under the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder. The Revenue Act of 1916, in so far as it imposes a tax upon the stockholder because of such dividend, contravenes the provisions of Article I, § 2, cl. 3, and Article I, § 9, cl. 4, of the Constitution, and to this extent is invalid notwithstanding the Sixteenth Amendment.
Judgment affirmed.
TITLE I — INCOME TAX.
PART I. — ON INDIVIDUALS.
Sec.-2 (a)'That, subject only to such exemptions and deductions as are hereinafter allowed, the net income of a taxable person shall include gains, profits, and income derived . . . , also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever: Provided, That the term "dividends" as used in this title shall be. held to mean any distribution made or ordered to be made by a corporation, . . . out Of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its share-holders, whether in cash or in stock of the corporation, . . which stock dividend shall be considered income, to the amount of its cash value.