SUPREME COURT OF THE UNITED STATES. Nos. 535 AND 536. OCTOBER TERM, 1921. 535. John D. Rockefeller, plaintiff in error, v. United States. 536. New York Trust Co. and Edith Hale Harkness, executors of the last will and testament of William L. Harkness, deceased, plaintiffs in error, v. William H. Edwards, collector of United States internal revenue for the second district of New York. ERROR to the District Court of the United States for the Southern District of New York. [Nov. 21, 1921.]

Mr. Justice PITNEY delivered the opinion of the court:

These two cases were argued together, turn upon like facts, and may be disposed of in a single opinion. They involve the legality of certain income taxes assessed against the plaintiff in error in the one case, and against the testator of plaintiffs in error in the other, under the income tax provisions of the Act of October 3, 1913 (ch. 16, 38 Stat. 114, 166-167), by reason of certain distributions of corporate stocks received by the respective taxpayers under the following circumstances: In and prior to the year 1914 the Prairie Oil & Gas Co., a corporation of the State of Kansas, was engaged in producing, purchasing, and selling crude petroleum, and transporting it through pipe lines owned by the company in the States of Kansas and Oklahoma, and elsewhere. At the same time the Ohio Oil Co., a corporation of the State of Ohio, was engaged in producing and manufacturing petroleum and mineral oil and transporting the same through pipe lines owned by it in the States of Ohio, Indiana, Illinois, and Pennsylvania. In the month of June, 1914, it was judicially determined by this court (The Pipe Line Cases, 234 U. S. 548), that with respect to the transportation business these companies were common carriers in interstate commerce, subject to the Act to regulate commerce as amended by Act of June 29, 1906 (ch. 3591, 34 Stat. 584), and as such subject to the supervision of the Interstate Commerce Commission. By Act of September 26, 1914 (ch. 311, 38 Stat. 717), the remainder of their business became subject to the supervision of the Federal Trade Commission. In order to avoid a probable conflict of Federal authority in case the combined business of production and transportation should continue to be carried on as theretofore, it was in each case, upon advice of counsel, determined that the pipe-line property should be owned and operated by a separate corporation. In the case of the Ohio company an added reason for segregation lay in the fact that by a section of the Ohio General Code its entire gross receipts, including those derived from business other than transportation, were subject to an annual assessment of 4 per cent chargeable against the gross receipts of companies engaged in the transportation business. For these reasons, the stockholders of the Prairie Oil & Gas Co. caused a corporation to be organized under the laws of the State of Kansas, by the name of the Prairie Pipe Line Co., to which all the pipeline property of the Prairie Oil & Gas Co. was transferred in consideration of the issue and delivery of the entire capital stock of the new company, to be distributed pro rata to the stockholders of the Prairie Oil & Gas Co. And similarly, the stockholders of the Ohio Oil Co. caused a corporation to be formed under the laws of that State, by the name of the Illinois Pipe Line Co., to which all the pipe-line property of the Ohio Oil Co. was transferred in consideration of the issue to it of the entire capital stock of the new company, which was to be distributed at once by the old company to its stockholders pro rata. These arrangements were carried out in like manner in both cases, except that in the case of the Kansas companies the stock of the pipe-line company was issued directly to the stockholders of the oil company, whereas in the case of the Ohio companies the pipe-line company issued its stock to the oil company, but in the same resolution by which the contract was made, an immediate distribution of the new stock among the oil company's stockholders was provided for, and in fact it was carried out. The aggregate valuation of the Prairie pipe lines was $27,000,000, that of the Ohio pipe lines $20,000,000, and the total capitalization of the respective pipe-line companies equaled these amounts.

In each case the oil company had a surplus in excess of the stated value of its pipe lines and of the par value of the total stock of the corresponding pipe-line company, so that the transfer of the pipe lines and the distribution

of the stock received for them left the capital of the respective oil companies unimpaired and required no reduction in their outstanding issues.

Messers. Rockfeller and Harkness, respectfully, were holders of large amounts of the stock of both the Prairie and the Ohio oil companies and in the distributions each received an amount of stock in each of the pipe-line companies proportionate to his holdings in the oil companies. This occurred in the year 1915. Neither Mr. Rockefeller nor Mr. Harkness nor the latter's executors sold any of the stock in the pipe-line companies.

Income tax assessments for the year 1915 were imposed upon Messrs. Rockefeller and Harkness, based upon the value of the stocks thus received as dividends; and these assessments are in question in the present suits, both of which were brought in the District Court of the United States for the Southern District of New York, one by the United States against Mr. Rockefeller, the other by the executors of Mr. Harkness against the collector. In each case the facts were specially pleaded so as to present the question whether the distribution of the stocks of the pipe-line companies among the stockholders of the oil companies constituted, under the circumstances, dividends within the meaning of the Act of 1913, and income within the meaning of the sixteenth amendment. In each case a final judgment was rendered sustaining the assessment, and the judgements are brought here by direct writs of error under section 238, Judicial Code, because of the constitutional question.

Under the facts as recited we deem it to be too plain for dispute that in both cases the new pipe-line company shares were in substance and effect distributed by the oil company to its stockholders; as much so in the case of the Kansas company, where the new stock went directly from the pipe-line company to the stockholders of the oil company, as in the case of the Ohio company, where the new stock went from the pipe-line company to the oil company, and by it was transferred to its stockholders. Looking to the substance of things the difference is unessential. In each case the consideration moved from the oil company in its corporate capacity, the new company's stock issued in exchange for it was distributed among the oil company's stockholders in their individual capacity, and was a substantial fruit of their ownership of stock in the oil company, in effect a dividend out of the accumulated surplus.

The facts are in all essentials indistinguishable from those presented in United States v. Phellis, decided this day. In these cases as in that, regarding the general effect of the entire transactions resulting from the combined action of the mass of stockholders, there was apparently little but a reorganization and financial readjustment of the affairs of the companies concerned, here a subdivision of companies, without immediate effect upon the personnel of the stockholders, or much difference in the aggregate corporate activities or properties. As in the Phellis case, the adoption of the new arrangement did not of itself produce any increase of wealth to the stockholders, since whatever was gained by each in the value of his new pipe-line stock was at the same moment withdrawn through a corresponding diminution of the value of his oil stock. Nevertheless the new stock represented assets of the oil companies standing in the place of the pipe-line properties that before had constituted portions of their surplus assets, and it was capable of division among stockholders as the pipeline properties were not. The distribution, whatever its effect upon the aggregate interests of the mass of stockholders, constituted in the case of each individual a gain in the form of actual exchangeable assets transferred to him from the oil company for his separate use in partial realization of his former indivisible and contingent interest in the corporate surplus. It was in substance and effect, not merely in form, a dividend of profits by the corporation, and individual income to the stockholder.

The opinion just delivered in United States v. Phellis sufficiently indicates the grounds of our conclusion that the judgment in each of the present cases must be affirmed.

Mr. Justice CLARKE took no part in the consideration or decision of these cases. Mr. Justice VAN DEVANTER and Mr. Justice MCREYNOLDS dissent.

SECTION 201, ARTICLE 1544: Dividends paid in property.

49-21-1957

(Ct. D. 19) T. D. 3270

INCOME TAXES-REVENUE ACT OF OCTOBER 3, 1913-DECISION OF SUPREME COURT.

1. INCOME-DIVIDENDS-INCOME IN WAY OF DIVIDENDS.

* * *

Under Section II (b) of the Act of October 3, 1913, declaring that income shall include, among other things, gains derived" from interest, rent, dividends, securities, or gains or profits and income derived from any source whatever," not everything in the form of a dividend must be treated as income, but income in the way of dividends shall be taxed.

2. SAME SURPLUS OF ACCUMULATED PROFITS DISTRIBUTED TO STOCKHOLDERS IN THE FORM OF STOCK OF ANOTHER CORPORATION-DISTINGUISHED FROM STOCK DIVIDENDS.

Where a stockholder, as the result of a reorganization and financial readjustment of the business of the corporation, received as a dividend on each share of common stock held by him two shares of the common stock of a new corporation, the dividend so received representing the surplus of accumulated profits of the first corporation, and the shares so received having a market value separate and distinct from the original share,such dividend was a gain, a profit, derived from his capital interest in the old company, and constituted individual income to the stockholder within the meaning of the income tax law of 1913. The rule laid down in Peabody v. Eisner (247 U. S., 347), followed; Eisner v. Macomber (252 U. S., 189) distinguished.

3. SAME EFFECT OF NO CHANGE IN AGGREGATE MARKET VALUE OF SHARES.

That a comparison of the market value of the stockholder's shares in the old corporation immediately before, with the aggregate market value of those shares plus the dividend shares immediately after the dividend showed no change in the aggregate is immaterial and is not a proper test for determining whether individual income, taxable against the stockholder, has been received by means of the dividend.

4. SAME EFFECT OF ANTECEDENT TRANSFERS OF STOCK.

The question whether a dividend made out of company profits constitutes income of the stockholder is not affected by antecedent transfers of the stock from hand to hand.

5. CORPORATIONS-REORGANIZATION-SEPARATE ENTITY.

Where a new corporation was formed under the laws of another State to take over the business and business assets of an old corporation, having authorized capital amounting to nearly four times the aggregate stock issues and funded debt of the old company, of which less than one-half was to be issued at once to the old company or its stockholders, held that the new corporation was not identical with the old, but was a separate and distinct corporate entity, despite the fact that both corporations had for the time being the same personnel of officers and stockholders, having the same proportionate holdings of stock in both companies.

6. INCOME EFFECT OF REORGANIZATION OF CORPORATION UPON AGGREGATE BODY OF STOCKHOLDERS.

The question whether an individual stockholder derived income in the true and substantial sense through receiving a part in the distribution of the new shares can not be tested by regarding alone the general effect of the reorganization upon the aggregate body of stockholders; the liability of a stockholder to pay an individual income tax must be tested by the effect of the transaction upon the individual.

TREASURY DEPARTMENT,

OFFICE OF COMMISSIONER OF INTERNAL REVENUE,
Washington, D. C.

To collectors of internal revenue and others concerned:

The appended decision of the Supreme Court of the United States, rendered November 21, 1921, in the case of United States v. C'. W. Phellis, is published for your information. The decision reverses the judgment of the Court of Claims in the case of C. W. Phellis v. United States.

Approved January 12, 1922:
A. W. MELLON,

D. H. BLAIR,

Commissioner of Internal Revenue.

Secretary of the Treasury.

SUPREME COURT OF THE UNITED STATES. No. 260. OCTOBER TERM, 1921. United States of America, appellant, v. C. W. Phellis.

APPEAL from the Court of Claims.

[Nov. 21, 1921.]

Mr. Justice PITNEY delivered the opinion of the court:

The court below sustained the claim of C. W. Phellis for a refund of certain moneys paid by him under protest in discharge of an additional tax assessed against him for the year 1915, based upon alleged income equivalent to the market value of 500 shares of stock of a Delaware corporation called the E. I. du Pont de Nemours & Co., received by him as a dividend upon his 250 shares of stock of the E. I. du Pont de Nemours Powder Co., a New Jersey corporation. The United States appeals.

From the findings of the Court of Claims, read in connection with claimant's petition, the following essential facts appear. In and prior to September, 1915, the New Jersey company had been engaged for many years in the business of manufacturing and selling explosives. Its funded debt and its capital stock at par values were as follows:

It had an excess of assets over liabilities showing a large surplus of accumulated profits; the precise amount is not important, except that it should be stated that it was sufficient to cover the dividend distribution presently to be mentioned. In that month a reorganization and financial adjustment of the business was resolved upon and carried into effect with the assent of a sufficient proportion of the stockholders, in which a new corporation was formed under the laws of Delaware with an authorized capital stock of $240,000,000 to consist in part of debenture stock bearing 6 per cent cumulative dividends, in part of common stock; and to this new corporation all the assets and good will of the New Jersey company were transferred as an entirety and as a going concern, as of October 1, 1915, at a valuation of $120,000,000, the new company assuming all the obligations of the old except its capital stock and funded debt. In payment of the consideration, the old company retained $1,484,100 in cash to be used in redemption of its outstanding 5 per cent mortgage bonds, and received $59,661,700 par value in debenture stock of the new company (of which $30,234,600 was to be used in taking up, share for share and dollar for dollar, the preferred stock of the old company and redeeming its 30-year bonds), and $58,854,200 par value of the common stock of the new company which was to be and was immediately distributed among the common stockholders of the old company as a dividend, paying them two shares of the new stock for each share they held in the old company. This plan was carried out by appropriate corporate action; the new company took over all the assets of the old company, and that company besides paying off its 5 per cent bonds

acquired debenture stock of the new company sufficient to liquidate its 4 per cent 30-year bonds and retire its preferred stock, additional debenture stock equal in amount at par to its own outstanding common stock, and also two shares of common stock of the Delaware corporation for each share of the outstanding common stock of the New Jersey corporation. Each holder of the New Jersey company's common stock (including claimant) retained his old stock and besides received a dividend of two shares for one in common stock of the Delaware company, and the New Jersey corporation retained in its treasury 6 per cent debenture stock of the Delaware corporation equivalent to the par value of its own outstanding common stock. The personnel of the stockholders and officers of the two corporations was on October 1, 1915, identical, the new company having elected the same officers as the old; and the holders of common stock in both corporations had the same proportionate stockholding in each. After the reorganization and the distribution of the stock of the Delaware corporation, the New Jersey corporation continued as a going concern, and still exists, but except for the redemption of its outstanding bonds, the exchange of debenture stock for its preferred stock, and the holding of debenture stock to an amount equivalent to its own outstanding common and the collection and disposition of dividends thereon, it has done no business. It is not, however, in process of liquidation. It has received as income upon the Delaware company's debenture stock held by it dividends to the amount of 6 per cent per annum, which it has paid out to its own stockholders including the claimant. The fair market value of the stock of the New Jersey corporation on September 30, 1915, prior to the reorganization, was $795 per share, and its fair market value, after the execution of the contracts between the two corporations, was on October 1, 1915, $100 per share. The fair market value of the stock of the Delaware corporation distributed as aforesaid was on October 1, 1915, $347.50 per share. The Commissioner of Internal Revenue held that the 500 shares of Delaware company stock acquired by claimant in the distribution was income of the value of $347.50 per share and assessed the additional tax accordingly.

The Court of Claims, observing that from the facts as found claimant's 250 shares of stock in the New Jersey corporation were worth on the market, prior to the transfer and dividend, precisely the same that the same shares plus the Delaware Company's shares received by him were worth thereafter, and that he did not gain any increase in the value of his aggregate holdings by the operation, held that the whole transaction was to be regarded as merely a financial reorganization of the business of the company, producing to him no profit and hence no income, and that the distribution was in effect a stock dividend nontaxable as income under the authority of Eisner v. Macomber (252 U. S. 189), and not within the rule of Peabody v. Eisner (247 U. S. 347).

We recognize the importance of regarding matters of substance and disregarding forms in applying the provisions of the sixteenth amendment and income tax laws enacted thereunder. In a number of cases besides those just cited we have under varying conditions followed the rule.-Lynch v. Turrish (247 U. S., 221); Southern Pacific Co. v. Lowe (247 U. S., 330); Gulf Oil Corporation v. Lewellyn (248 U. S., 71).

*

The Act under which the tax now in question was imposed (Act of Oct. 3, 1913, ch. 16, 38 Stat., 114, 166-167), declares that income shall include, among other things, gains derived "from interest, rent, dividends, securities, or the transaction of any lawful business carried on for gain or profit, or gains or profits and income derived from any source whatever." Disregarding the slight looseness of construction, we interpret "gains, profits, and income derived from dividends," etc., as meaning not that everything in the form of a dividend must be treated as income, but that income derived in the way of dividends shall be taxed. Hence the inquiry must be whether the shares of stock in the new company received by claimant as a dividend by reason of his ownership of stock in the old company constituted (to apply the tests laid down in Eisner v. Macomber [252 U. S., 189, 207]), a gain derived from capital, not a gain accruing to capital, nor 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, and coming in-that is, received or drawn by the claimant for his separate use, benefit, and disposal.

Claimant's capital investment was represented by his New Jersey shares. Whatever increment of value had accrued to them prior to September 30, 1915, by reason of the surplus profits that theretofore had been accumulated by the company, was still a part of claimant's capital, from which as yet he had de