Court Opinion

ID: 9445279
Source: CourtListenerOpinion
Date Created: 2023-08-03 21:24:32.27784+00
Date Added: 2024-06-11T17:30:11.827221
License: Public Domain

CLARK, Chief Judge
(dissenting).
In a noteworthy article under the arresting title, Erosion of the Tax Base and Rate Structure, 11 Tax L.Rev. 203 (Í956), the late Randolph E. Paul, “our most eminent tax commentator,” 1 points out persuasively that we have a far less progressive income tax system than is popularly' supposed by either the advocates or the opponents thereof, and that the progression remaining after considerable erosion over the course of time works a number of gross discriminations, notably against wage earners. After pointing Out how the high progressive rates beeomé largely - theoretical in the upper brackets because of various exclusions, particularly adjustments for realized capital gains, he goes on to discuss leakages in the tax structure and stresses the preferential treatment accorded capital gains — preferences which “probably are the major reason for the disparity between theoretical and actual rates of income taxation in the high income brackets.” His suggestions of the real dangers for the income tax in “these variations in the rate structure and ero-sions of the potential tax base,” leading *619to substantially “a system of taxation by confession,” are arresting discussions of social policy. The same theme is stressed by another distinguished commentator, Professor Surrey, Definitional Problems in Capital Gains Taxation, 69 Harv.L.Rev. 985, 1009 (1956): “A wide area of the problem of defining capital gain thus became a shell game, with the taxpayer in control because he could determine under which legal shell to place the asset.” And he continues, at page 1015: “ * * * the difficulties inherent in the present approach to the definition of capital gain are formidable almost beyond belief,” and “there is no escape from plunging deeper and deeper into this technical jungle of the definition of capital gain.”
No better illustration of the trend deplored by these outstanding experts can be found than the present case. The more the tax statute becomes complicated, the more, I suppose, must it be a question of form over substance; and perhaps we must follow the literal language of the statute at all costs for fear of worse troubles if we try to look for equities. But this means that the statute becomes increasingly a matter of particular cases, and that the distinguished members of the tax bar need only bring their clients’ situations within some purely formal statutory terms to secure exemption or relief from burdensome taxation. The problem becomes increasingly one of semantics only, soluble by astute and sophisticated counsel. ' Perhaps this cannot be helped; but I do feel that we should preserve equities where we can, and not make the game too easy for our brethren of the tax bar lest they lose their cunning for lack of challenge.
My brothers’ opinion herein, able though it is from this logistic standpoint, seems to me to illustrate the point in its continued reiteration that the gains here involved are necessarily only those from the appreciation in value of capital assets. True it is that here we have real estate mortgages, the proceeds of which are to be used by the mortgagors to build improved structures on the real estate. Were we to stop right there, we would indeed have a place for literal application of statutory terms granting preferential tax treatment. So my brothers insist: “The real source of the distributions wai-3 the appreciation in the value of the property.” But I am bound to feel that “real” here can be used only in a Pickwickian sense. For the real source of the funds here distributed was bank funds insured by the FHA, i. e., supported by the bottomless Treasury of the United States. But since one does not draw even federal funds without some legal basis, we must look to the occasion for the advances, which was, as is conceded, the building of these improved dwellings at prices less than the government estimate. If, therefore, we go beneath the surface, we find _ that, realistically considered, this was anything but the case of a realty owner investing in capital to improve the premises in the hope of later realized gain. Here the risk was taken over by the Government, and the money was in hand at once. The situation, in other words, was that of an experienced workman realizing proper and adequate payment for the fruit of his toils. This is clearly brought out in the letter of October 27, 1949, quoted in the opinion explaining the grounds of the receipts as based in the superior expertise of the three builders here chiefly involved. That they worked through corporations, rather than as individuals, does not change the nature of the gains as being this type of monetary award for services performed, rather than the profits from ■investments which have turned out well.
.Hence to point up the distinction it would seem desirable to view the builders here — the Messrs. Gross, Mr. Morton, -and their corporations — not as the owners, since their capital was not put at risk, but as only skilled artisans of the land improvements so far as concerns the portions of their activities here involved. Of course, as to other portions not shielded by governmental protection, they were ordinary risk bearers and entitled to the capital gains preference when, their investment turned out well. But *620here they received at once and paid out the fruits of their skills as superior workmen and builders erecting structures where others would bear the loss if any ensued. This is made the clearer by the litigation now developing to secure the return of these windfalls, as noted in the opinion. See Sarner v. Mason, 3 Cir., 228 F.2d 176, certiorari denied 351 U.S. 924, 76 S.Ct. 781. Respondents are going on the basis that these gains are all theirs, and so must we — until and unless other legal determination is made.
So viewed realistically, must we still say that the corporate distributions of the moneys thus obtained (1) clearly and necessarily are not payments of dividends out of corporate earnings or profits and (2) of necessity are capital gains under the Internal Revenue Code of 1939, § 115(a) and (d) ? I submit that this is putting the cart before the horse by looking for the preferential exception before we see if we have the normal situation when taxpayers receive money in hand. For there can be no question that the distributions made here fall within the broad definition of gross income provided by the Internal Revenue Code of 1939, § 22(a). Recently the Supreme Court has emphasized the breadth of this provision: “We have repeatedly held that in defining ‘gross income’ as broadly as it did in § 22(a) Congress intended to ‘tax all gains except those specifically exempted.’ See, e. g., C. I. R. v. Glen-shaw Glass Co., 348 U.S. 426, 429-430, 75 S.Ct. 473, 476, 99 L.Ed. 483.” C. I. R. v. Lo Bue, 351 U.S. 243, 246, 76 S.Ct. 800, 803, finding a taxable gain upon the exercise of an incentive stock option granted a corporate employee. See also C. I. R. v. Glenshaw Glass Co., supra, 348 U.S. 426, 75 S.Ct. 473, 99 L.Ed. 483, holding amounts received as punitive damages for fraud and antitrust violations includable in gross receipts, and General American Investors Co. v. C. I. R., 348 U.S. 434, 75 S.Ct. 478, 99 L.Ed. 504, holding “insider profits” recovered under § 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), likewise includable in gross receipts. Compare also Rutkin v. United States, 343 U.S. 130, 72 S.Ct. 571, 96 L.Ed. 833, and United States v. Bruswitz, 2 Cir., 219 F.2d 59, certiorari denied Bruswitz v. United States, 349 U.S. 913, 75 S.Ct. 600, 99 L.Ed. 1247, as to the proceeds of extortion; and see discussion in Rapp, Some Recent Developments in the Concept of Taxable Income, 11 Tax L.Rev. 329, 331, 358-371 (1956).
On the other hand, the preferential capital gains provisions of the Internal Revenue Code which are exceptions from its normal tax requirements must be “narrowly applied * * * to effectuate the basic congressional purpose.” Corn Products Refining Co. v. C. I. R., 350 U.S. 46, 52, 76 S.Ct. 20, 24. These exceptional provisions were intended “to relieve the taxpayer from these excessive tax burdens on gains resulting from a conversion of capital investments, and to remove the deterrent effect of those burdens on such conversions.” Burnet v. Harmel, 287 U.S. 103, 106, 53 S.Ct. 74, 75, 77 L.Ed. 199. This situation hardly seems one which Congress had in mind when it provided for capital gains treatment of certain transactions. Here the corporations were able to borrow funds in excess of their actual needs. These funds they promptly distributed to their stockholders when they saw that the construction costs would be less than as estimated in the then clear expectation that they would be able to pay back the loans out of their subsequent earnings and profits. In no way was the capital investment of the stockholders affected; the corporations merely passed on to the stockholders these excess mortgage “windfalls” soon to be covered by corporate earnings.
According to taxpayers’ argument we have to determine only whether the corporate distributions are made from earnings and profits; if they are not, then they become automatically entitled to special capital gains treatment. And since the corporate funds so distributed do not appear to fit the tailored description of earnings or profits, the conclusion that *621the distributions are capital assets easily follows. But this conclusion is subject to some of the questions or infirmities attendant upon all pat solutions of difficult problems. A mandate that everything which is not white shall be considered black may be all that is necessary to force things which are speckled or grayish to be taken as black. But there is sure to remain some doubt whether Congress actually so intended. Possibly in view of the wide sweep of income under § 22(a) the legislators over the years may have thought they were starting from the other viewpoint, namely, that what was not ebony was substantially white; at least the constant attempts to plug gaps discovered by astute tax lawyers may suggest some question as to the facile solution. Especially must this be so when it is noted that the result depends solely upon an unstated, but assumed, meaning to one of the more occult concepts of the Code, namely, a corporation’s “earnings or profits”.
There is much store of learning on this subject, but all to the demonstration that the meaning is elusive. As one author has acutely observed: “Although the concept of ‘earnings or profits’ is the very basis of the whole structure of taxing corporate dividends, no one really knows precisely what they are. The Code provides a punctilious description of ‘dividends’ as distributions out of ‘earnings or profits’ and then leaves ‘earnings or profits’ intensely undefined. This leaves the job of divining its meaning primarily to the Commissioner.” Albrecht, “Dividends” and “Earnings or Profits,” 7 Tax L.Rev. 157, 181 (1952).2 He continues: “As usual in such circumstances, the starting point is legislative intent, but an examination of legislative history merely confirms the suspicion that Congress itself had no clear idea of what it had in mind.” This perhaps explains why the various essays made by the parties into the history have been singularly unproductive. This is essentially a new problem where supposedly analogous precedents shed little real illumination and the shifts in position of the Bureau of Internal Revenue serve only to highlight the difficulties. The author arrest-ingly concludes, page 183: “Fundamentally then, ‘earnings or profits’ is an economic concept,” and proceeds to an attempted reconcilement of “taxable net income” and “earnings or profits,” with a showing of situations where the latter may exceed the former.
I do not find anything, therefore, to prevent giving natural effect to the economic basis of the gains here as analyzed above. True, the respondents and the opinion make much of what they consider the petitioner’s concession that these gains are not corporate “earnings or profits,” but are perhaps a new and intermediate class of corporate assets. Concessions by revenue officials are of doubtful validity at best; to me there always seems a tendency to press them beyond anything intended. Here petitioner, I think, is only accepting obvious law as to realty appreciation to point to distinctions — as indeed do I. In any event I cannot see the ordinary corporate executive viewing these assets as capital, so that he would not dare pay them out for fear of impairing capital. So the concept of capital as here unimpaired is of substantial significance. Indeed, the approach indicated seems the natural one, since there appears nothing in the statute (and indeed in the precedents) to bar an economic approach to the problem. Thus there is perhaps real significance (as we have heretofore found) in the fact that § 115(d) is captioned “Other distributions from capital.” [Emphasis added.] As its caption indicates, § 115 (d) “is rather designed to subject to capital gains taxation those distributions which have left the capital of the corporation impaired.” Judge, now Mr. Justice, Harlan, in C. I. R. v. Hirshon Trust, 2 Cir., 213 F.2d 523, 528, certio-rari denied 348 U.S. 861, 75 S.Ct. 85, 99 L.Ed. 679.
*622Here surely there has -been no impairment of .capital. In fact the distributing corporations- specifically wrote up their realty prior to making the distributions and then paid the dividends out of this “Surplus-Arising from Realty Appreciation.” It is difficult, therefore, to maintain that the distributions were made out of capital unless we accept a novel definition of “capital” which includes everything that is not earnings or profits. It is quite reasonable that, as under the scheme of § 115(d), a return of contributed capital .should be applied against the basis of the stock for which it was contributed. But such a provision has no reasonable application to mortgage windfalls distributed in anticipation of future profits; and' an unstrained reading of the statute requires no different conclusion. There is no indication that Congress did or could have anticipated this novel use of the corporation as conduit for excess mortgage'loans. Nor could it have intended to permit wholesale circumvention of the ordinary application of the taxing principles through the simple device of a borrowing against future earnings and prompt distribution of the borrowed funds.
Hence I would conclude that taxpayers have not - succeeded in bringing these windfall distributions under the special capital gains treatment of § 115(d); and they remain taxable as ordinary income under the general provisions of- § 22(a). In the case of the 4 Mars Home Corporations, the distributions were not out of borrowed funds, but out of depreciation reserves. Again, though a different accounting device, was used, this distribution similarly failed to impair capital and was made in anticipation of future earnings and. profits. It is indistinguishable . from thp accompanying distribution out of .borrowed funds, and •the same result must follow. The decision, in my view, should be- reversed for the increased tax computation thus indicated

. Rudick, Randolph E. Paul, 11 Tax L.Rev. 201 (1956), quoting Judge Jerome Frank.

. For another valuable article showing the fluidity of the term, see Emmanuel, Earnings and Profits: An Accounting Concept? 4 Tax L.Rev. 494 (1949).