Court Opinion

ID: 6916898
Source: CourtListenerOpinion
Date Created: 2022-07-23 22:44:48.932503+00
Date Added: 2024-06-11T16:06:40.982620
License: Public Domain

DANAHER, Circuit Judge
(dissenting).
Deficiencies in income tax were asserted by the Assessor against the petitioners as individual resident taxpayers who had received cash and securities upon the liquidation of Engineering and Research Corporation, Maryland Corporation (ERCO), in which they had been stockholders.
An income tax may be levied upon the “net income” of a taxpayer resident in the District, to be sure, but the words “net income” are defined to mean “the gross income of a taxpayer less the deductions allowed by this article.” D.C. Code § 47-1557 (1951). In turn, the words “gross income” by definition include, in part, income derived from “dealings in property, whether real or personal, other than capital assets,” D.C.Code § 47-1557a (1951). (Emphasis supplied.) Certainly the shares in the hands of the stockholders constituted “capital assets,”1 whatever the value of those shares might be, since they were “held by the taxpayer for more than two years.”, D.C.Code § 47-1551 (c) (Z) (1951). The Code further provides that “gains from the sale or exchange of any capital asset as defined in this article” are capital gains, D.C.Code § 47-1557(b) (11) (1951).2
The Tax Court concluded that the cash and securities distributed by ERCO constituted “dividends” within the meaning of D.C.Code § 47-1551c(m) (1951), which in pertinent part reads:
“(m) The word ‘dividend’ means any distribution made by a corporation (domestic or foreign) to its stockholders or members, out of its earnings, profits, or surplus (other than paid-in surplus), whenever earned by the corporation and whether made in cash or any other property * * * and whether distributed prior to, during, upon, or after liquidation or dissolution of the corporation: Provided, however, That in the ease of any dividend which is distributed other than in cash or stock in the same class in the corporation and not exempted from tax under this article, the basis of tax to the recipient thereof shall be the market value of such property at the time of such distribution * * (Emphasis supplied.)
It seems to me that the key to the foregoing section, as here applied, must be *657found in the language “whenever earned by the corporation.” I think the District Code, as amended in 1947, had been simply drawn, and intentionally so, in contradistinction from the far more complicated Internal Revenue Code. The draftsmen sought to reach a liquidation, whether it be partial or complete. They sought to avoid the many complications such as have arisen under the federal law.
The draftsmen knew that distributions “in kind” have given rise to myriad problems under the federal law. See, e.g., Commissioner of Internal Revenue v. Hirshon Trust, 2 Cir., 1954, 213 F.2d 523, certiorari denied 1954, 348 U.S. 861, 75 S.Ct. 85, 99 L.Ed. 679. Thus, for the purposes of the tax law of the District of Columbia, as to distributions “in kind,” they added the proviso, above noted, defining the taxpayer’s “basis” but only as to property so distributed which is “not exempted from tax.” Surely Congress did not stultify itself by this deliberately selected language in this very section.
To recapitulate, Congress sought simply to class as dividends to stockholders the distribution of earnings, whenever paid out, and whether in complete or partial liquidation or dissolution or otherwise. Reverting to the definition of “dividend,” we see that its reach applies to a distribution by a corporation of its property, whether it be cash or otherwise, if that distribution is made “out of its earnings, profits, or surplus (other than paid-in surplus), whenever earned by the corporation.” 3
I see no complexity inherent in the sweep of this language. The Tax Court said in its opinion that “There can be no doubt that all of such items, with the exception of the $190,000 capital item, were surplus.” Thus the Tax Court treated the entire sum, whether in cash or stock, paid by ACF to ERCO other than paid-in capital, as “surplus,” and hence as a dividend or “surplus” income to the stockholders. I believe its error stems from its loose and all-inclusive classification of “surplus,” without regard to the type of surplus. Obviously, the Code itself excludes “paid-in surplus.” The term certainly.must be taken to exclude unearned surplus, or that represented by appreciation in value. Mr. Justice Brandéis makes the point for me in his opinion in Edwards v. Douglas, 269 U. S. 204, at page 214, 46 S.Ct. 85, at page 88, 70 L.Ed. 235, where he says:
“The word ‘surplus’ is a term commonly employed in corporate finance and accounting to designate an account on corporate books. * * * The surplus account represents the net assets of a corporation in excess of all liabilities including its capital stock. This surplus may be ‘paid-in surplus,’ as where the stock is issued at a price above par. [In our case paid-in surplus is specifically excluded.] It may be ‘earned surplus,’ as where it was derived wholly from undistributed profits. [In our case, I deem at least $613,628.54 to be “earned surplus,” specifically subject to tax.] Or it may, among other things, represent the increase in valuation of land or other assets made upon a revaluation of the company’s fixed property.” (Emphasis supplied.)4
*658I think the case should be remanded to the Tax Court for a determination of the several elements as separately distinguished by Mr. Justice Brandéis. The words “surplus * * * whenever earned by the corporation” have not here been broken down by evidence of record.
The petitioners had been arguing that no part of the sum paid by ACF was subject to the deficiency tax here asserted. Yet it is perfectly clear that as at December 31, 1953, there was an earned surplus balance of $54,241.64. Again, the corporation between January 1 and November 15, 1954, had net income of $559,386.90. Surely these two items constituted earned surplus, within the meaning of the Code, subject to tax, when distributed, as “dividends.” Exclusive of capital, the balance was represented by notes and accounts receivable, buildings and other fixed depreciable assets and inventories. There were contracts, work in process and other elements, no doubt. We do not know what they are or the value ascribed to them.
In short, between January, 1937, and November, 1954, the stockholders saw their capital investment grow. No doubt, some earnings were ploughed back. No doubt, some dividends were paid. But the experience of the corporation was one of progress. Its good will was enhanced. Its potential for doing business was expanded. Its management developed a product in demand under Government contract — for all we know, the only such company in the nation in a specialty field.5 The value of the stock increased accordingly in the hands of its holders, irrespective of what elements contributed to that enhanced value. Thus, it was that invested capital of $190,000 by the time of the ACF transaction represented asset value of $3 million. That amount, in what appears to have been an arm’s-length transaction, was what ACF agreed to pay. The stockholders bound themselves expressly by contract not to use the ERCO name, or any similar name, and not for five years to compete with ACF, or even indirectly to become interested in a competitor. ACF saw value in that restriction and ERCO’s shareholders were entitled to compensation for it. The contract with ERCO bound ACF to pay $3 million, and ERCO was bound to transfer and did transfer “all of Seller’s then existing assets and business, as a going concern, including, without limitation, all rights to the use of the name Engineering and Research Corporation (or any variant thereof) and all patents, applications for patents, trade-marks and licenses.” 6
Then, upon liquidation, ERCO’s stockholders surrendered their stock. They exchanged the value back of that stock for $3 million. To the extent that the amounts received thereafter constituted a distribution of surplus earned by the corporation, such amounts were dividends under the Code section here applicable. To the extent that such amounts so distributed reflected value, not earned, they also were properly carried on ERCO’s books as surplus, possessing, within the meaning of the Code, a capital asset value when related to the stock in the hands of the shareholders. Whatever the exact tax consequences may be depends upon the elements back of that valuation, to be measured in terms of what portion was earned, and on this point no findings have been made. That there was some capital gain to the shareholders seems beyond peradventure.7
*659My colleagues recognize, I see, that if these stockholders had sold their stock to a third person, there would be no income tax because there would be no “dividend,” as they construe the term. That is the way the law clearly points, they concede. Presumably the same result would follow had the stock been sold to ACF. Yet they observe that unless their construction of the term “dividend” is here adopted, these stockholders will likewise not be required to pay an income tax on the unearned asset value included in the ERCO “surplus.”
I think the result they deplore reflects precisely the purpose of the statute which presents a policy question with which we are not concerned. The 1947 amendment expanded the earlier language8 so as to reach earnings or profits distributed upon liquidation or dissolution, but otherwise made no change in the principle. If a “dividend” in a corporate liquidation is not a distribution of corporate earnings, but represents only a return of unearned increment, the stockholders have received no more in value than they had before surrendering their stock. They have merely exchanged their capital, the shares being evidence of their ownership, for the valuation itself, whether it be distributed in dollars or in property. The Code reaches corporate distributions out of earnings, whether distributed currently in a given tax year as a “dividend” in the usual sense, or declared but not paid until later, or earned, but not distributed at any time until either by a partial or complete liquidation or dissolution. Thus equality of tax treatment is accorded to District residents as to income from corporate earnings. It seems to me the scheme of the statute in these several respects is completely clear.9
In sum, when the statute says that gross income shall not include capital gains resulting from the sale or exchange of capital assets as defined in the Code, it seems to me to assimilate that portion of the District law to the federal law with years of experience behind it. Thus shareholders in the District who wish to speculate must treat as ordinary income, gains on transactions in capital assets held for less than two years. But investors, who through a corporation help build asset value and whose holdings appreciate due to many valid causes, some, perhaps, wholly fortuitous, are bound upon liquidation of the corporate medium to pay a District income tax only upon such “surplus” as shall have been earned by the corporation. Whatever may be the tax liability of shareholders, such as these, to the federal Government, I think their District liability has expressly and purposefully been limited.
I would remand for a determination of whatever facts may measure District income tax liability according to the criteria I have suggested.10

. Garrett v. District of Columbia, 1946, 81 U.S.App.D.C. 874, 159 F.2d 457, certiorari denied 1947, 330 U.S. 885, 67 S. Ct. 971, 91 L.Ed. 1282.

. The general definitions in the Code “are the generally accepted ones for the words defined.” S.Rep.No.280 to accompany H.R. 3787, Vol. 2 Senate Reports (1947) 80th Cong., 1st Sess.

. Compare D.C.Codo § 47-1543(16) (1940):
“The word ‘dividend’ moans any distribution made by a corporation out of its earnings or profits to its stockholders or members whether such distribution be made in cash, or any other property, other than stock of the same class in the corporation. It includes such portion of the assets of a corporation distributed at the time of dissolution as are in effect a distribution of earnings.” (Emphasis added.)

. So it was that the parties stipulated that over and above repaid capital, amounts received by the stockholders wore “paid and delivered out of surplus of [ERGO] and to have been acquired by said corporation from (1) its operations commencing- January, 1937, and terminating November 15, 1954, and (2) the proceeds of sale of its business to ACE * * (Emphasis supplied.)

. As to the nature of at least some of ERCO’s business, see Greene v. McElroy, 1958, 103 U.S.App.D.C. 87, 254 F.2d 944.

. ERCO’s contract to sell its business in which the stockholders individually joined, bound ERCO to transfer to ACF net assets of not less than “$586,429, the net worth of Seller as disclosed by its [bal-anee sheet]. The term ‘net assets’ of Seller as used in this Section shall be deemed to mean the book value of the assets of Seller less its liabilities, including in liabilities all reserves and accruals but exeluding capital and surplus accounts.” (Emphasis supplied.)

. I do not explore the extent to which these stockholders may be liable to fed*659eral taxes because of the distribution, and, of course, we have not considered at all the various aspects of ERCO’s liability to the Government.

. See note 3 supra.

. The Assessor had issued no regulations which spell out the term “dividend.” I am confident my colleagues will not wish to be understood as saying that a “dividend,” as they define it, will result in taxability as though upon income if a stockholder takes a loss when a corporation upon liquidation returns less than his invested capital. The point is arguable, nevertheless. I read the majority opinion as intended to deal only with the distribution of amounts which “exceed the cost of the stock and represent corporate earnings.” I have sought to make clear for my part that “surplus” may moan a great deal more than what has been earned by the corporation, and may include amounts which “exceed the cost of the stock.” There must be hundreds of corporations in the District — not to mention corporations located elsewhere — • whose stock is owned by District residents, the holdings of which are concentrated in real estate, or oil properties or mining ventures, for purposes of illustration, which vastly appreciated in value in recent years. That increment in value is surplus, largely unearned. See Edwards v. Douglas, supra.

. See Commissioner of Internal Revenue v. Munter, 1947, 331 U.S. 210, 216, 217, 67 S.Ct. 1175, 91 L.Ed. 1441.