*333 and Peabody v. Eisner, Collector, 247, prior to January 1, 1913; but the payment U. S. 347, 38 Sup. Ct. 546, 62 L. Ed. The material facts are as follows: Prior to January 1, 1913, and at all times material to the case, plaintiff, a corporation organized under the laws of the state of Kentucky owned all the capital stock of the Central Pacific Railway Company, a corporation of the state of Utah, including the stock registered in the names of the directors.1 This situation existed continuously from the incorporation of the Railway Company in the year 1899. That company is the successor of the Central Pacific Railroad Company and acquired all of its properties, which constitute a part of a large system of railways owned or controlled by the Southern Pacific Company. The latter company, besides being sole stockholder, was in the actual physical possession of the railroads and all other assets of the Railway Company, and in charge of it operations, which were conducted in accordance with the terms of a lease made by the predecessor company to the Southern Pacific and assumed by the Railway Company, the effect of which was that the Southern Pacific should pay to the lessor company $10,000 per annum for organization expenses, should operate the railroads, branches, and leased lines belonging to the lessor, and account annually for the net earnings, and if these exceeded 6 per cent. on the existing capital stock of the lessor the lessee should retain to itself one-half of the excess; advances by the lessee for account of the lessor were to bear lawful interest, and the lessee was to be entitled at any time and from time to time to refund to itself its advances and interest out of any net earnings which might be in its hands. The provisions of the lease were observed by both corporations for bookkeeping purposes. The Southern Pacific acted as cashier and banker for the entire system; the Central Pacific kept no bank account, its earnings being deposited with the bank account of the Southern Pacific; and if the Central Pacific needed money for additions and betterments or for making up a deficit of current earnings, the necessary funds were advanced by the Southern Pacific, As a result of these operations and of the conversion of certain capital assets of the Central Pacific Company, that company showed upon its books a large surplus accumulated prior to January 1, 1913, principally in the form of a debit against the Southern Pacific, which at the same time, as sole stock holder, was entitled to any and all dividends that might be declared, and being in control of the board of directors was able to and did control the dividend policy. The dividends in question were declared and paid during the first six months of the year 1914 out of this surplus of the Central Pacific accumulated 1 There was another question, concerning a dividend paid by the Reward Oil Company, whose stock likewise was owned by the Southern Pacific Company, but the contention of plaintiff in error respecting this item has been abandoned. was only constructive, being carried into effect by bookkeeping entries which simply reduced the apparent surplus of the Central Pacific and reduced the apparent indebtedness of the Southern Pacific to the Central Pacific by precisely the amount of the dividends. The question is whether the dividends received under these circumstances and in this manner by the Southern Pacific Company were taxable as income of that company under the Income Tax Act of 1913.2 The act provides, in section 2, paragraph A, subdivision 1 (38 Stat. 166), "that there shall be levied, assessed, collected and paid annually upon the entire net income arising or accruing from all sources in the preceding calendar year" to every person residing in, the United States a tax of 1 per centum per annum, with exceptions not now material. By paragraph G (a), p. 172, it is provided "that the normal tax hereinbefore imposed upon individuals [1 per cent.] likewise shall be levied, assessed, and paid annually upon the entire net income arising or accruing from all sources during the preceding calendar organized year to every corporation in the United States," with other provisions not now material. It is provided in paragraph G (b), as to domestic corporations, that such net income shall be ascertained by deducting from the gross amount of the income of the corporation (1) ordinary and necessary expenses paid within the year in the maintenance and operation of its business and properties, including rentals and the like; (2) losses sustained within the year and not compensated by inallowance for depreciation by use, wear and surance or otherwise, including a reasonable tear of property, if any, and in the case of mines a certain allowance for depletion of ores and other natural deposits; (3) interest accrued and paid within the year upon indebtedness of the corporation, within prescribed limits; (4) national and state taxes paid. It will be observed that moneys received as dividends upon the stock of other corporations are not deducted, as they are in computing the income of individuals for the purpose of the normal tax under this act (page 167), and as they were in computing the Tax Act of August 5, 1909 (chapter 6, 36 income of a corporation under the Excise Stat. 11, 113, § 38). [1] By paragraph G (c), the tax upon corporations is to be computed upon the entire net income accrued within each calendar year, but for the year 1913 only upon the net income accrued from March 1 to December 31, to be ascertained by taking five-sixths of In addition, a question was made in the District Court as to a special dividend declared by the Central Pacific out of the proceeds of sale of certain land on Long Island, taken in satisfaction of a debt and sold in December, 1913. As to this, however, no argument is submitted by plaintiff in error, the facts are not clear, and we pass it without consideration. *335 the entire net income for the calendar year. I under which this court held, in Collector v. The purpose to refrain from taxing income Hubbard, 12 Wall. 1, 16, 20 L. Ed. 272, that that accrued prior to March 1, 1913, and to exclude from consideration in making the computation any income that accrued in a preceding calendar year, is made plain by the provision last referred to; indeed, the Sixteenth Amendment, under which for the first time Congress was authorized to tax income from property without apportioning the tax among the states according to population, received the approval of the requisite number of states only in February, 1913. Pollock v. Farmers' Loan & Trust Co., 157 U. S. 429, 581, 15 Sup. Ct. 673, 39 L. Ed. 759; Id., 158 U. S. 601, 637, 15 Sup. Ct. 912, 39 L. Ed. 1108; Brushaber v. Union Pacific R. R., 240 U. S. 1, 16, 36 Sup. Ct. 236, 60 L. Ed. 493, Ann. Cas. 1917B, 713, L. R. A. 1917D, 414. *336 an individual was taxable upon his propor- Our [2] We must reject in this case, as we have rejected in cases arising under the Corporation Excise Tax Act of 1909 (Doyle, Collector, v. Mitchell Brothers Co., 247 U. S. 179, 38 Sup. Ct. 467, C2 L. Ed. - and Hays, Collector, v. Gauley Mountain Coal Co., 247 U. S. 189, 38 Sup. Ct. 470, 62 L. Ed. decided May 20, 1918), the broad contention submitted in behalf of the government that all receipts-everything that comes in-are income within the proper definition of the term "gross income," and that the entire proceeds of a conversion of capital assets, in whatever form and under whatever circumstances accomplished, should be treated as gross income. Certainly the term "income" has no broader meaning in the 1913 act than in that We base our conclusion in the present case of 1909 (see Stratton's Independence v. How-upon the view that it was the purpose and inbert, 231 U. S. 399, 416, 417, 34 Sup. Ct. 136, 58 L. Ed. 285), and for the present purpose we assume there is no difference in its meaning as used in the two acts. This being so, we are bound to consider accumulations that accrued to a corporation prior to January 1, 1913, as being capital, not income, for the purposes of the act. And we perceive no adequate ground for a distinction, in this regard, between an accumulation of surplus earnings, and the increment due to an appreciation in value of the assets of the taxpayer. tent of Congress, while taxing "the entire net income arising or accruing from all sources" during each year commencing with the 1st day of March, 1913, to refrain from taxing that which, in mere form only, bore the appearance of income accruing after that date, while in truth and in substance it accrued before; and upon the fact that the Central Pacific and the Southern Pacific were in substance identical because of the complete ownership and control which the lat "For the purpose of this additional tax the taxable income of any individual shall embrace the [3, 4] That the dividends in question were paid out of a surplus that accrued to the share to which he would be entitled of the gains Central Pacific prior to January 1, 1913, is and profits, if divided or distributed, whether undisputed; and we deem it to be equally divided or distributed or not, of all corporations, clear that this surplus accrued to the South-joint-stock companies, or associations however cre ated or organized, formed or fraudulently availed ern Pacific Company prior to that date, in or for the purpose of preventing the imposition every substantial sense pertinent to the pres- of such tax through the medium of permitting ent inquiry, and hence underwent nothing such gains and profits to accumulate instead of more than a change of form when the divi dends were declared. We do not rest this upon the view that for the purposes of the act of 1913 stockholders in the ordinary case have the same interest in the accumulated earnings of the company before as after the declaration of dividends. The act is quite different in this respect from the Income Tax Act of June 30, 1864 (chapter 173, 13 Stat. 223, 281, 282), being divided or distributed; and the fact that *338 Judgment reversed, and the cause remanded for further proceedings in conformity with this opinion. Mr. Justice CLARKE dissents. (247 U. S. 333) LYNCH, Collector of Internal Revenue, v. HORNBY. (Argued March 4, 5, and 6, 1918. Decided June 3, 1918.) No. 422. 1. INTERNAL REVENUE 7 INCOME TAX INCOME TAX The retroactivity of Income Tax Act Oct. 1913, c. 16, 38 Stat. 114, from the date of its passage to a date not prior to the adoption of Const. Amend. 16, allowing Congress to tax income from property without apportioning the tax among the states according to population, was permissible. 2. INTERNAL REVENUE 7 LAW-AUTHORITY OF CONGRESS. Under Const. Amend. 16, authorizing taxes on income from property without apportioning tion, Congress was at liberty to tax as income, the tax among the states according to populawithout apportionment, everything that became income, in the ordinary sense of the word, after the adoption of the amendment, including divithe ordinary course, though paid from a surdends received by a corporate stockholder in plus of corporate assets previously existing. 3. INTERNAL REVENUE 7 INCOME TAX LAW-"INCOME"-"DIVIDEND." ter possessed over the former, as stockholder The case turns upon its very peculiar facts, and is distinguishable from others in which the question of the identity of a controlling stockholder with his corporation has been raised. Pullman Car Co. v. Missouri Pacific Co., 115 U. S. 587, 596, 6 Sup. Ct. 194, 29 L. Ed. 499; Peterson v. Chicago, Rock Island & Pacific Ry., 205 U. S. 364, 391, 27 Sup. Ct. 513, 51 L. Ed. 841. Under Income Tax Act Oct. 3, 1913, § 2, and declaring that the net income of every perpars. A, B, imposing a tax on net incomes, son shall include gains, profits, and income derived from salaries, wages, etc., also from interest, rent, dividends, and securities, all dividends declared and paid in the ordinary course of business by a corporation to its stockholders, after the taking effect of the act, whether from current earnings or from the accumulated survalue of corporate assets, notwithstanding it plus, made up of past earnings or increase in accrued to the corporation prior to the effective date of the act, are income, and taxable as such; the expression "dividends" embracing rate stock, analogous to interest and rent rethe tangible and recurrent returns upon corpoceived upon other forms of invested capital. [Ed. Note.-For other definitions, see Words and Phrases, First and Second Series, Dividend; Income.] 4. INTERNAL REVENUE 7 INCOME TAX LAW-CONSTRUCTION. Provisions in Income Tax Acts (Act Sept. 8, 1916, c. 463, 39 Stat. 756, and Act Oct. 3, 1917, c. 63, 40 Stat. 300), relating to dividends cannot be deemed declaratory of the meaning of the treated as a concession to the equity of stockterm as used in Act Oct. 3, 1913, but should be holders, in view of the attacks on the validity of the earlier act, which imposed taxes on dividends declared out of earnings or profits which accrued before it went into effect. On Writ of Certiorari to the United States Circuit Court of Appeals for the Eighth Circuit. Action by H. C. Hornby against E. J. Lynch, Collector of Internal Revenue for the District of Minnesota. A judgment for plaintiff was affirmed by the Circuit Court of Appeals (236 Fed. 661, 149 C. C. A. 657), and For other cases see same topic and KEY-NUMBER in all Key-Numbered Digests and Indexes *340 defendant brings error. Reversed and re- the distribution in question was a single and manded for further proceedings. final dividend received by Turrish from the Payette Company in liquidation of the entire assets and business of the company and a return to him of the value of his stock upon the surrender of his entire interest in the company, at a price that represented its in Mr. Solicitor General Davis, for petitioner. Messrs. A. W. Clapp and Newell Clapp, both of St. Paul, Minn., and H. Oldenburg, of Carlton, Minn., for respondent. *Mr. Justice PITNEY delivered the opinion trinsic value at and before March 1, 1913, of the Court. Hornby, the respondent, recovered a judgment in the United States District Court against Lynch, as Collector of Internal Revenue, for the return of $171, assessed as an additional income tax under the Act of October 3, 1913 (chapter 16, 38 Stat. 114, 166), and paid under protest. The Circuit Court of Appeals affirmed the judgment (236 Fed. 661, 149 C. C. A. 657), and the case comes here on certiorari. It was submitted at the same time with Lynch, Collector, v. L. Ed., Turrish, 247 U. S. 221, 38 Sup. Ct. 537, 62 247 U. S. 347, 38 Sup. Ct. 546, 62 L. Ed. arising under the same act, and this day de cided. no when the Income Tax Act took effect. clare. Gibbons v. Mahon, 136 U. S. 549, 557, assessed, collected and paid annually upon the "A. Subdivision 1. That there shall be levied, entire net income arising or accruing from all sources in the preceding calendar year to every citizen of the United States, and to every person residing in the United States, * a tax of 1 per centum per annum upon such income, except as hereinafter provided. * * The facts, in brief, are as follows: Hornby, from 1906 to 1915, was the owner of 434 (out of 10,000) shares of the capital stock of the Cloquet Lumber Company, an Iowa corporation, which for more than a quarter of a century had been engaged in purchasing timber lands, manufacturing the timber into lumber, and selling it. Its shares had a par value of $100 each, making the entire capital stock $1,000,000. On and prior to March 1, 1913, by the increase of the value of its timber lands and through its business operations, the total property of the company had come to be worth $4,000,000, and Hornby's stock, the par value of which was $43,400, had become worth at least $150,000. In the year 1914 the company was engaged in cutting its standing timber, manufacturing it into lumber, selling the lumber, and distributing the proceeds among its stockholders. In that year it thus distributed dividends aggregating $650,000, of which $240,000, or 24 per cent. of the par value of the capital stock, was derived from current earnings, and $410,000 from conversion into money of property that it owned or in which it had an interest on March 1, 1913. Hornby's share of the latter amount was $17,794, and, this not having been included in his income tax return, the Commissioner of Internal RevThere is a graduated additional tax, comenue levied an additional tax of $171 on ac-monly known as a "surtax," upon net income count of it, and this forms the subject of the in excess of $20,000, including income from present suit. dividends, and for the purpose of this additional tax and deductions as are hereinafter allowed, the "B. That, subject only to such exemptions net income of a taxable person shall include gains, profits, and income derived from salaries, wages, or compensation for personal service, curities, or the transaction of any lawful busialso from interest, rent, dividends, seness carried on for gain or profit, or gains or profits and income derived from any source whatever." * Among the deductions allowed for the purpose of the normal tax is: "Seventh, the amount received as dividends upon the stock or from the net earnings of any corporation, which is taxable upon its net income as hereinafter provided." * * * The case was tried in the District Court and argued in the Circuit Court of Appeals "the taxable income of any individual shall emtogether with Lynch, Collector, v. Tarrish, brace the share to which he would be entitled 236 Fed. 653, 149 C. C. A. 649, and was treat of the gains and profits, if divided or distributed as presenting substantially the same ques-ed, whether divided or distributed or not, of all corporations *formed or fraudulently tion upon the merits. In our opinion it is availed of for the purpose of preventing the imdistinguishable from the Turrish Case, where position of such tax through the medium of * permitting such gains and profits to accumu- liberty to treat the dividends as coming to late instead of being divided or distributed." *344 him ab extra, and as constituting a part of his income when they came to hand. * * ** [4] In the more recent Income Tax Acts, provisions have been inserted for the purpose of excluding from the effect of the tax any dividends declared out of earnings or profits that accrued prior to March 1, 1913. This originated with the act of September 8, 1916, and has been continued in the act of October 3, 1917.1 We are referred to the legislative It is evident that Congress intended to draw and did draw a distinction between a Hence we construe the provision of the stockholder's undivided share or interest in act that "the net income of a taxable person the gains and profits of a corporation, prior shall include gains, profits, and income deto the declaration of a dividend, and his rived from interest, rent, diviparticipation in the dividends declared and dends, or gains or profits and inpaid; treating the latter, in ordinary cir- come derived from any source whatever" as cumstances, as a part of his income for the including (for the purposes of the additional purposes of the surtax, and not regarding tax) all dividends declared and paid in the the former as taxable income unless fraudu-ordinary course of business by a corporation lently accumulated for the purpose of evad- to its stockholders after the taking effect ing the tax. of the act (March 1, 1913), whether from curThis treatment of undivided profits ap-rent earnings, or from the accumulated surplies only to profits permitted to accumulate plus made up of past earnings or increase in after the taking effect of the act, since only value of corporate assets, notwithstanding it with respect to these is a fraudulent pur- accrued to the corporation in whole or in pose of evading the tax predicable. Corpo- part prior to March 1, 1913. In short, the rate profits that accumulated before the act word "dividends" was employed in the act took effect stand on a different footing. As as descriptive of one kind of gain to the into these, however, just as we deem the leg-dividual stockholder; dividends being treatislative intent manifest to tax the stockhold-ed as the tangible and recurrent returns uper with respect to such accumulations only on his stock, analogous to the interest and if and when, and to the extent that, his in- rent received upon other forms of invested terest in them comes to fruition as income, capital. 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 pre-existing surplus. The act took effect on March 1, 1913, a few days after the requisite number of states had given approval to the Sixteenth Amendment, under which for the first time Congress was empowered to tax income from property without apportioning the tax among the states according to population. Southern Pacific Co. v. Lowe, supra. That the retroactivity of the act from the date of its passage (October 3, 1913) to a date not prior to the adoption of the amendment was permissible is settled by Brushaber v. Union Pacific R. R., 240 U. S. 1, 20, 36 Sup. Ct. 236, 60 L. Ed. 493, Ann. Cas. 1917B, 713, L. R. A. 1917D, 414. And we deem it equally clear that 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 had in a surplus of corporate assets previously existing. Dividends are the appropriate fruit of stock ownership, are commonly reckoned as income, and are expended as such by the stockholder without regard to whether they are declared from the most recent earnings, or from a surplus accumulated from the earnings of the past, or are based upon the increased value of the property of the corporation. The stockholder is, in the ordinary case, a different entity from the corporation, and Congress was at 38 SUP.CT.-35 1 In Act Sept. 8, 1916, c. 463, 39 Stat. 756, 757, which took the place of the act of 1913, the substance of what we have quoted from paragraph B of the 1913 act was embodied in section 2 (a), Comp. St. 1916, § 6336b, but with this proviso: "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 shareholders, whether in cash or in stock of the corporation," etc. And by Act Oct. 3, 1917, c. 63, 40 Stat. 300, 329, 337, 338, section 2 (a) of the 1916 act was amended by being repeated without the proviso (page 329), while the a inserted as new section-31 (a)proviso was and to it was added a subsection, (b), as follows: "(b) Any distribution made to the shareholders in the year or members of a corporation nineteen hundred and seventeen, or subsequent tax years, shall be deemed to have been made profits or suplus, and shall constitute a part of the annual income of the distributee for the year in which received, and shall be taxed to the distributee at the rates prescribed by law for the vears in which such profits or surplus were accumulated by the corporation, but nothing from the most recently accumulated undivided herein shall be construed as taxing any earnings or profits accrued prior to March first, nineteen hundred and thirteen, but such earnings or profits may be distributed in stock dividends or otherwise, exempt from the tax, after the distribution of earnings and profits accrued since March first, nineteen hundred and thirteen, has been made. This subdivision shall not apply to any distribution made prior to August sixth, nineteen hundred and seventeen, out of earnings or profits accrued prior to March first, nineteen hundred and thirteen." |