(40 Sup.Ct.)

In

board feels justified in stating that if the prop- | dend representing profits earned since March osition to increase the capital stock is acted 1, 1913. The dividend was paid by direct ison favorably, it will be proper in the near fu-sue of the stock to her according to the simture to declare a cash dividend of 100 per cent. ple method described above, pursued also by and to allow the stockholders the privilege pro the Indiana and Nebraska companies. rata according to their holdings, to purchase the new stock at par, the plan being to allow 1917 she was taxed under the federal law the stockholders, if they desire, to use their on the stock dividend so received at its par cash dividend to pay for the new stock." value of $100 a share, as income received during the year 1916. Such a stock dividend is income, as distinguished from capital, both under the law of New York and under the law of California, because in both states every dividend representing profits is deemed to be income, whether paid in cash or in stock. It had been so held in New York, where the question arose as between life tenant and remainderman, Lowry v. Farmers' Loan & Trust Co., 172 N. Y. 137, 64 N. E. 796; Matter of Osborne, 209 N. Y. 450, 103 N. E. 723, 823, 50 L. R. A. (N. S.) 510, Ann. Cas. 1915A, 298; and also, where the question arose in matters of taxation, People v.

The increase of stock was voted. The company then paid a cash dividend of 100 per cent., payable May 1, 1917, again offering to such stockholders the right to subscribe for an equal amount of new stock at par and to apply the cash dividend in payment therefor. Moody's Manual, describing the transaction with exactness, says first that the stock was increased from $3,000,000 to $6,000,000, "a cash dividend of 100 per cent., payable May 1, 1917, being exchanged for one share of new stock, the equivalent of a 100 per cent. stock dividend." But later in the report giving, as customary in the Manual the dividend record of the company, the Manual says: "A stock dividend of 200 per cent. was paid February 14, 1914, and one of 100 per cent. on May 1, 1197." And in reporting specifically the income account of the company for a series of years ending December 31, covering net profits, dividends paid and surplus for the year, it gives, as the aggregate of dividends for the year 1917, $660,000 (which was the aggregate paid on the quarterly cash dividend-5 per cent. January and April; 6 per cent. July and October), and adds in a note: "In addition a stock dividend of 100 per cent. was paid during the year." The

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Wall Street Journal of *May 2, 1917, p. 2, quotes the 1917 "high" price for Standard Oil of Kentucky as "375 ex stock dividend." It thus appears that among financiers and investors the distribution of the stock, by whichever method effected, is called a stock dividend; that the two methods by which accumulated profits are legally retained for corporate purposes and at the same time distributed as dividends are recognized by them to be equivalents; and that the financial results to the corporation and to the stockholders of the two methods are substantially the same-unless a difference results from the application of the federal Income Tax Law. Mrs. Macomber, a citizen and resident of New York, was, in the year 1916, a stockholder in the Standard Oil Company (of California), a corporation organized under the laws of California and having its principal place of business in that state. During that year she received from the company a stock divi

• Moody's, p. 1547; Commercial and Financial Chronicle, vol. 97, pp. 1589, 1827, 1903; vol. 98, pp. 76, 457; vol. 103, p. 2348. Poor's Manual of Industrials (1918), p. 2210, in giving the "comparative income account" of the company, describes the 1914 dividend as "stock dividend paid (200 per cent.)$2,000,000," and describes the 1917 dividend as $3,000,000 special cash dividend."

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Glynn, *130 App. Div. 332, 114 N. Y. Supp. 460; Id. 198 N. Y. 605, 92 N. E. 1097. It has been so held in California, where the question appears to have arisen only in controversies between life tenant and remainderman. Estate of Duffill, 183 Pac. 387.

It is conceded that if the stock dividend paid to Mrs. Macomber had been made by the more complicated method pursued by the Standard Oil Company of Kentucky; that is, issuing rights to take new stock pro rata and paying to each stockholder simultaneously a dividend in cash sufficient in amount to enable him to pay for this pro rata of new stock to be purchased-the dividend so paid to him would have been taxable as income, whether he retained the cash or whether he returned it to the corporation in payment for his pro rata of new stock. But it is contended that, because the simple method was adopted of having the new stock issued direct to the stockholders as paid-up stock, the new stock is not to be deemed income, whether she retained it or converted it into cash by sale. If such a different result can flow merely from the difference in the method pursued, it must be because Congress is without power to tax as income of the stockholder either the stock received under the latter method or the proceeds of its sale; for Congress has, by the provisions in the Revenue Act of 1916, expressly declared its purpose to make stock dividends, by whichever method paid, taxable as income. The Sixteenth Amendment, proclaimed February 25, 1913, declares:

"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."

The Revenue Act of September 8, 1916, c. 463, § 2a, 39 Stat. 756, 757, provided:

*Suppose that a corporation having power to buy and sell its own stock, purchases, in the interval between its regular dividend profits, some of its own common stock as a dates, with moneys derived from current

of purchase to sell it before the next divitemporary investment, intending at the time dividends, but later, deeming it inadvisable dend date and to use the proceeds in paying either to sell this stock or to raise by borrowing the money necessary to pay the regular dividend in cash, declares a dividend that in such a case the dividend in common payable in this stock; can any one doubt stock would be income of the stockholder and constitutionally taxable as such? See Green v. Bissell, 79 Conn. 547, 65 Atl. 1056, 8 L. R. A. (N. S.) 1011, 118 Am. St. Rep. 156, 9 Ann. Cas. 287; Leland v. Hayden, 102 Mass. 542. And would it not likewise be income of the stockholder subject to taxation if the purpose of the company in buying the stock so distributed had been from the beginning to take it off the market and distribute it among the stockholders as a dividend, and the company actually did so? And proceeding a short step further: Suppose that a corporation decided to capitalize some of its accumulated profits by creating additional common stock and selling the same to raise working capital, but after the stock has been issued and certificates therefor are deliver

(40 Sup.Ct.)

ed to the bankers for sale, general financial conditions make it undesirable to market the stock and the company concludes that it is wiser to husband, for working capital, the cash which it had intended to use in paying stockholders a dividend, and, instead, to pay the dividend in the common stock which it had planned to sell; would not the stock so distributed be a distribution of profits—and hence, when received, be income of the stockholder and taxable as such? If this be conceded, why should it not be equally income of the stockholder, and taxable as such, if the common stock created by capitalizing profits, had been originally created for the

$229

express purpose of being dis*tributed as a dividend to the stockholder who afterwards

received it?

Second. It has been said that a dividend

payable in bonds or preferred stock created for the purpose of distributing profits may be income and taxable as such, but that the case is different where the distribution is in

The objection that there has been no segregation is presented also in another form. It is argued that until there is a segregation, the stockholder cannot know whether he has really received gains; since the gains may be invested in plant or merchandise or other property and perhaps be later lost. But is not this equally true of the share of a partner in the year's profits of the firm or, indeed, of the profits of the individual who is engaged in business alone? And is it not true, also, when dividends are paid in cash? The gains of a business, whether conducted by an individual, by a firm or by a corporation, are ordinarily reinvested in large part. Many a cash dividend honestly declared as a distribution of profits, proves later to have been paid out of capital, because errors in forecast prevent correct ascertainment of values. Until a business adventure has been

completely liquidated, it can never be deter

mined with certainty whether there have been profits unless the returns at least exceeded the capital originally invested. Business men, dealing with the problem practically, fix necessarily periods and rules for determining whether there have been net profits-that is, income or gains. They protect themselves from being seriously misled by adopting a system of depreciation charges and reserves. Then, they act upon their own determination, whether profits have been made. Congress in legislating has wisely adopted their practices as its own rules

of action.

would have been within the power of ConThird. The Government urges that it gress to have taxed as income of the stockholder his pro rata share of undistributed profits earned, even if no stock dividend representing it had been paid. Strong reaSee The Collector v. Hubbard, 12 Wall. sons may be assigned for such a view. 1, 20 L. Ed. 272. The undivided share of a partner in the year's undistribut

*231

common stock created for that purpose. Various reasons are assigned for making this distinction. One is that the proportion of the stockholder's ownership to the aggregate number of the shares of the company is not changed by the distribution. But that is equally true where the dividend is paid in its bonds or in its preferred stock. Furthermore, neither maintenance nor change in the proportionate ownership of a stockholder in a corporation has any bearing upon the question here involved. Another reason assigned is that the value of the old stock held is reduced approximately by the value of the new stock received, so that the stockholder after receipt of the stock dividend has no more than he had before it was paid. That is equally true whether the dividend be paid in cash or in other property, for instance, bonds, scrip or preferred stock of the company. The payment from profits of a large cash dividend, and even a small one, custom-ed profits of his firm *is taxable as income arily lowers the then market value of stock of the partner, although the share in the because the undivided property represented gain is not evidenced by any action taken by each share has been correspondingly re- by the firm. Why may not the stockholder's duced. The argument which appears to be interest in the gains of the company? The most strongly urged for the stockholders is, law finds no difficulty in disregarding the that when a stock dividend is made, no por- corporate fiction whenever that is deemed tion of the assets of the company is thereby necessary to attain a just result. Linn Timsegregated for the stockholder. But does the ber Co. v. United States, 236 U. S. 574, 35 issue of new bonds or of preferred stock Sup. Ct. 440, 59 L. Ed. 725. See Morawetz created for use as a dividend result in any on Corporations (2d Ed.) §§ 227-231; Cook segregation of assets for the stockholder? on Corporations (7th Ed.) §§ 663, 661. The In each case he receives a piece of paper stockholder's interest in the property of the which entitles him to certain rights in the corporation differs, not fundamentally but undivided property. Clearly segregation of in form only, from the interest of a partner assets in a physical sense is not an essenin the property of the firm. There is much tial of income. The year's gains of a part- authority for the proposition that, under our ner is taxable as income, although there, law, a partnership or joint stock company is just as distinct and palpable an entity in likewise, no *segregation of his share in the the idea of the law, as distinguished from gains from that of his partners is had.

*230

the individuals composing it, as is a cor

poration. 5 No reason appears, why Con- "surplus" account distinguishing between gress, in legislating under a grant of power so comprehensive as that authorizing the levy of an income tax, should be limited by the particular view of the relation of the stockholder to the corporation and its property which may, in the absence of legislation, have been taken by this court. But we have no occasion to decide the question whether Congress might have taxed to the stockholder his undivided share of the corporation's earnings. For Congress has in this act limited the income tax to that share of the stockholder in the earnings which is, in effect, distributed by means of the stock dividend paid. In other words to render the stockholder taxable there must be both earnings made and a dividend paid. Neither earnings without dividend-nor a dividend

(40 Sup.Ct.)

hon, 136 U. S. 549, 10 Sup. Ct. 1057, 34 L. Ed. | the rule of administration for the District of 525, which involved a question arising be- Columbia the so-called Massachusetts rule, tween life tenant and remainderman. So far the opinion being delivered in 1890 by Mr. as concerns Towne v. Eisner we have only to Justice Gray. Since then the same question bear in mind what was there said (245 has come up for decision in many of the U. S. 425, 38 Sup. Ct. 159, 62 L. Ed. 372, states. The so-called Massachusetts rule, alL. R. A. 1918D, 254): "But it is not neces- though approved by this court, has found fasarily true that income means the same vor in only a few states. The so-called Pennthing in the Constitution and the [an] act." 7 sylvania rule, on the other hand, has been Gibbons v. Mahon is even less an author- adopted since by so many of the states (inity for a narrow construction of the power cluding New York and California), that it has to tax incomes conferred by the Sixteenth come to be known as the "American rule." Amendment. In that case the court was re- Whether, in view of these facts and the pracquired to determine how, in the administra- tical results of the operation of the two rules tion of an estate in the District of Columbia, as shown by the experience of the 30 years a stock dividend, representing profits, re- which have elapsed since the decision in Gibceived after the decedent's death, should be bons v. Mahon, it might be desirable for this disposed of as between life tenant and re- court to reconsider the question there decidmainderman. The question was in essence: ed, as *some other courts have done (see 29 What shall the intention of the testator be Harvard Law Review, 551), we have no occapresumed to have been? On this question sion to consider in this case. For, as this there was great diversity of opinion and court there pointed out (136 U. S. 560, 1059 practice in the courts of English-speaking [34 L. Ed. 525]), the question involved was countries. Three well-defined rules were then competing for acceptance; two of these ests in particular shares," and not, as in Baiinvolves an arbitrary rule of distribution, the third equitable apportionment. See Cookey v. Railroad Co., 22 Wall. 604, 22 L. Ed. 840, a question "between the corporation and on Corporations (7th Ed.) §§ 552-558. the government, and [which] depended upon the terms of a statute carefully framed to

1. The so-called English rule, declared in

1799, by Brander v. Brander, 4 Ves. Jr. 800,

*235

that a dividend rep*resenting profits, whether in cash, stock or other property, belongs to the life tenant if it was a regular or ordinary dividend, and belongs to the remainderman if it was an extraordinary dividend.

*236

one "between the owners of successive inter

prevent corporations from evading payment of the tax upon their earnings."

We have, however, not merely argument; that "there is no inherent, necessary and imwe have examples which should convince us mutable reason why stock dividends should sioner v. Putnam, 227 Mass. 522, 533, 116 N. always be treated as capital." Tax CommisE. 904, L. R. A. 1917F, 806. The Supreme Ju

2. The so-called Massachusetts rule, declared in 1868 by Minot v. Paine, 99 Mass. 101, 96 Am. Dec. 705, that a dividend represent-dicial Court of Massachusetts has steadfastly ing profits, whether regular, ordinary or extraordinary, if in cash belongs to the life

tenant, and if in stock belongs to the remainderman.

adhered, despite ever-renewed protest, to the rule that every stock dividend is, as between

life tenant and remainderman, capital and not income. But in construing the Massachu3. The so-called Pennsylvania rule declar-setts Income Tax Amendment, which is subed in 1857 by Earp's Appeal, 28 Pa. 368, that stantially identical with the federal amendwhere a stock dividend is paid, the court ment, that court held that the Legislature shall inquire into the circumstances under was thereby empowered to levy an income tax which the fund had been earned and accumuupon stock dividends representing profits. lated out of which the dividend, whether a The courts of England have, with some relaxregular, an ordinary or an extraordinary ation, adhered to their rule that every exone, was paid. If it finds that the stock traordinary dividend is, as between life tendividend was paid out of profits earned since ant and remainderman, to be deemed capital. the decedent's death, the stock dividend be- But in 1913 the Judicial Committee of the longs to the life tenant; if the court finds Privy Council held that a stock dividend repthat the stock dividend was paid from cap-resenting accumulated profits was taxable ital or from profits earned before the de-like an ordinary cash dividend, Swan Brewcedent's death, the stock dividend belongs ery Company, Limited v. The King, L. R. to the remainderman. 1914 A. C. 231. In dismissing the appeal This court adopted in Gibbons v. Mahon as these words of the Chief Justice of the Supreme Court of Western Australia were quoted (page 236) which show that the facts involved were identical with those in the case at bar:

1 Compare Rugg, C. J., in Tax Commissioner v. Putnam, 227 Mass. 522, 533, 116 N. E. 904, 910 (L. R. A. 1917F, 806): "However strong such an argument might be when urged as to the interpretation of a statute, it is not of prevailing force as to the broad "Had the company distributed the £101,450 considerations involved in the interpretation of an amendment to the Constitution adopted under the among the shareholders and had the shareholders conditions preceding and attendant upon the rati-repaid such sums to the company as the price fication of the forty-fourth amendment."

of the 81,160 new shares, the duty on the £101,