Republic of the Philippines SUPREME COURT

Manila

EN BANC

G.R. No. L-17518 October 30, 1922

FREDERICK C. FISHER, plaintiff-appellant, vs. WENCESLAO TRINIDAD, Collector of Internal Revenue, defendant-appellee.

JOHNSON, J.:

ISSUE:

Are the "stock dividends" in the present case "income" and taxable as such under the provisions of section 25 of Act No. 2833? While the appellant presents other important questions, under the view which we have taken of the facts and the law applicable to the present case, we deem it unnecessary to discuss them now.

The defendant demurred to the petition in the lower court.

FACTS:

Philippine American Drug Company was a corporation duly organized and existing under the laws of the Philippine Islands;

the appellant was a stockholder in said corporation;

The drug company declared a "stock dividend";

that the proportionate share of said stock divided of the appellant was P24,800; that the stock dividend for that amount was issued to the appellant;

that thereafter, in the month of March, 1920, Fisher, upon demand of the CIR, paid under protest, and voluntarily, unto the appellee the sum of P889.91 as income tax on said stock dividend.

For the recovery of that sum (P889.91) the present action was instituted.

The defendant demurred to the petition upon the ground that it did not state facts sufficient to constitute cause of action.

The demurrer was sustained and the plaintiff appealed.

To sustain his appeal the appellant cites and relies on some decisions of the Supreme Court of the United States as will as the decisions of the supreme court of some of the states of the Union, in which the questions before us, based upon similar statutes, was discussed. Among the most important decisions may be mentioned the following: Towne vs. Eisner, 245 U.S., 418; Doyle vs.

Mitchell Bors. Co., 247 U.S., 179; Eisner vs. Macomber, 252 U.S., 189; Dekoven vs Alsop, 205 Ill., 309; 63 L.R.A., 587; Kaufman vs. Charlottesville Woolen Mills, 93 Va., 673.

In each of said cases an effort was made to collect an "income tax" upon "stock dividends" and in each case it was held that "stock dividends" were capital and not an "income" and therefore not subject to the "income tax" law.

The appellee admits the doctrine established in the case of Eisner vs. Macomber (252 U.S., 189) that a "stock dividend" is not "income" but argues that said Act No. 2833, in imposing the tax on the stock dividend, does not violate the provisions of the Jones Law. The appellee further argues that the statute of the United States providing for tax upon stock dividends is different from the statute of the Philippine Islands, and therefore the decision of the Supreme Court of the United States should not be followed in interpreting the statute in force here.

For the purpose of ascertaining the difference in the said statutes ( (United States and Philippine Islands), providing for an income tax in the United States as well as that in the Philippine Islands, the two statutes are here quoted for the purpose of determining the difference, if any, in the language of the two statutes.

Chapter 463 of an Act of Congress of September 8, 1916, in its title 1 provides for the collection of an "income tax." Section 2 of said Act attempts to define what is an income. The definition follows:

That the term "dividends" as used in this title shall be held to mean any distribution made or ordered to made by a corporation, . . . which stock dividend shall be considered income, to the amount of its cash value.

Act No. 2833 of the Philippine Legislature is an Act establishing "an income tax." Section 25 of said Act attempts to define the application of the income tax. The definition follows:

The term "dividends" as used in this Law 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, . . . . Stock dividend shall be considered income, to the amount of the earnings or profits distributed.

It will be noted from a reading of the provisions of the two laws above quoted that the writer of the law of the Philippine Islands must have had before him the statute of the United States. No important argument can be based upon the slight different in the wording of the two sections.

It is further argued by the appellee that there are no constitutional limitations upon the power of the Philippine Legislature such as exist in the United States, and in support of that contention, he cites a number of decisions. There is no question that the Philippine Legislature may provide for the payment of an income tax, but it cannot, under the guise of an income tax, collect a tax on property which is not an "income." The Philippine Legislature can not impose a tax upon "property" under a law which provides for a tax upon "income" only. The Philippine Legislature has no power to provide a tax upon "automobiles" only, and under that law collect a tax upon acarreton or bull cart. Constitutional limitations, that is to say, a statute expressly adopted for one purpose cannot, without amendment, be applied to another purpose which is entirely distinct and different. A statute providing for an income tax cannot be construed to cover property which is not, in fact income. The Legislature cannot, by a statutory declaration, change the real nature of a tax which it imposes. A law which imposes an important tax on rice only cannot be construed to an impose an importation tax on corn.

It is true that the statute in question provides for an income tax and contains a further provision that "stock dividends" shall be considered income and are therefore subject to income tax provided for in said law. If "stock dividends" are not "income" then the law permits a tax upon something not within the purpose and intent of the law.

It becomes necessary in this connection to ascertain what is an "income in order that we may be able to determine whether "stock dividends" are "income" in the sense that the word is used in the statute.

Perhaps it would be more logical to determine first what are "stock dividends" in order that we may more clearly understand their relation to "income."

Generally speaking, stock dividends represent undistributed increase in the capital of corporations or firms, joint stock companies, etc., etc., for a particular period. They are used to show the increased interest or proportional shares in the capital of each stockholder.

In other words, the inventory of the property of the corporation, etc., for particular period shows an increase in its capital, so that the stock theretofore issued does not show the real value of the stockholder's interest, and additional stock is issued showing the increase in the actual capital, or property, or assets of the corporation, etc.

To illustrate: A and B form a corporation with an authorized capital of P10,000 for the purpose of opening and conducting a drug store, with assets of the value of P2,000, and each contributes P1,000. Their entire assets are invested in drugs and put upon the shelves in their place of business. They commence business without a cent in the treasury. Every dollar contributed is invested. Shares of stock to the amount of P1,000 are issued to each of the incorporators, which represent the actual investment and entire assets of the corporation. Business for the first year is good. Merchandise is sold, and purchased, to meet the demands of the growing trade. At the end of the first year an inventory of the assets of the corporation is made, and it is then ascertained that the assets or capital of the corporation on hand amount to P4,000, with no debts, and still not a cent in the treasury. All of the receipts during the year have been reinvested in the business. Neither of the stockholders have withdrawn a penny from the business during the year. Every peso received for the sale of merchandise was immediately used in the purchase of new stock — new supplies. At the close of the year there is not a centavo in the treasury, with which either A or B could buy a cup of coffee or a pair of shoes for his family. At the beginning of the year they were P2,000, and at the end of the year they were P4,000, and neither of the stockholders have received a centavo from the business during the year. At the close of the year, when it is discovered that the assets are P4,000 and not P2,000, instead of selling the extra merchandise on hand and thereby reducing the business to its original capital, they agree among themselves to increase the capital they agree among themselves to increase the capital issued and for that purpose issue additional stock in the form of "stock dividends" or additional stock of P1,000 each, which represents the actual increase of the shares of interest in the business. At the beginning of the year each stockholder held one-half interest in the capital. At the close of the year, and after the issue of the said stock dividends, they each still have one-half interest in the business. The capital of the corporation increased during the year, but has either of them received an income? It is not denied, for the purpose of ordinary taxation, that the taxable property of the corporation at the beginning of the year was P2,000, that at the close of the year it wasP4,000, and that the tax rolls should be changed in accordance with the changed conditions in the business. In other words, the ordinary tax should be increased by P2,000.

Another illustration: C and D organized a corporation for agricultural purposes with an authorized capital stock of P20,000 each contributing P5,000. With that capital they purchased a farm and, with it, one hundred head of cattle. Every peso contributed is invested. There is no money in the treasury.

Much time and labor was expanded during the year by the stockholders on the farm in the way of improvements. Neither received a centavo during the year from the farm or the cattle. At the beginning of the year the assets of the corporation, including the farm and the cattle, were P10,000, and at the close of the year and inventory of the property of the corporation is made and it is then found that they have the same farm with its improvements and two hundred head of cattle by natural increase. At the end of the year it is also discovered that, by reason of business changes, the farm and the cattle both have increased in value, and that the value of the corporate property is now P20,000 instead of P10,000 as it was at the beginning of the year. The incorporators instead of reducing the property to its original capital, by selling off a part of its, issue to themselves "stock dividends" to represent the proportional value or interest of each of the stockholders in the increased capital at the close of the year. There is still not a centavo in the treasury and neither has withdrawn a peso from the business during the year. No part of the farm or cattle has been sold and not a single peso was received out of the rents or profits of the capital of the corporation by the stockholders.

Another illustration: A, an individual farmer, buys a farm with one hundred head of cattle for the sum of P10,000. At the end of the first year, by reason of business conditions and the increase of the value of both real estate and personal property, it is discovered that the value of the farm and the cattle is P20,000. A, during the year, has received nothing from the farm or the cattle. His books at the beginning of the year show that he had property of the value of P10,000. His books at the close of the year show that he has property of the value of P20,000. A is not a corporation. The assets of his business are not shown therefore by certificates of stock. His books, however, show that the value of his property has increased during the year by P10,000, under any theory of business or law, be regarded as an "income" upon which the farmer can be required to pay an income tax? Is there any difference in law in the condition of A in this illustration and the condition of A and B in the immediately preceding illustration? Can the increase of the value of the property in either case be regarded as an "income" and be subjected to the payment of the income tax under the law?

Each of the foregoing illustrations, it is asserted, is analogous to the case before us and, in view of that fact, let us ascertain how lexicographers and the courts have defined an "income." The New Standard Dictionary, edition of 1915, defines an income as "the amount of money coming to a person or corporation within a specified time whether as payment or corporation within a specified time whether as payment for services, interest, or profit from investment." Webster's International Dictionary defines an income as "the receipt, salary; especially, the annual receipts of a private person or a corporation from property." Bouvier, in his law dictionary, says that an "income" in the federal constitution and income tax act, is used in its common or ordinary meaning and not in its technical, or economic sense. (146 Northwestern Reporter, 812) Mr. Black, in his law dictionary, says "An income is the returnin money from one's business, labor, or capital invested; gains, profit or private revenue." "An income tax is a tax on the yearly profits arising from property , professions, trades, and offices."

The Supreme Court of the United States, in the case o Gray vs. Darlington (82 U.S., 653), said in speaking of income that mere advance in value in no sense constitutes the "income" specified in the revenue law as "income" of the owner for the year in which the sale of the property was made. Such advance constitutes and can be treated merely as an increase of capital. (In re Graham's Estate, 198 Pa., 216; Appeal of Braun, 105 Pa., 414.)

Mr. Justice Hughes, later Associate Justice of the Supreme Court of the United States and now Secretary of State of the United States, in his argument before the Supreme Court of the United States in the case of Towne vs. Eisner, supra, defined an "income" in an income tax law, unless it is otherwise specified, to mean cash or its equivalent. It does not mean choses in action or unrealized increments in the value of the property, and cites in support of the definition, the definition given by the Supreme Court in the case of Gray vs. Darlington, supra.

In the case of Towne vs. Eisner, supra, Mr. Justice Holmes, speaking for the court, said: "Notwithstanding the thoughtful discussion that the case received below, we cannot doubt that the dividend was capital as well for the purposes of the Income Tax Law. . . . 'A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders. Its property is not diminished and their interest are not increased. . . . The proportional interest of each shareholder remains the same. . . .' In short, the corporation is no poorer and the stockholder is no richer then they were before." (Gibbons vs. Mahon, 136 U.S., 549, 559, 560; Logan County vs. U.S., 169 U.S., 255, 261).

In the case of Doyle vs. Mitchell Bros. Co. (247 U.S., 179, Mr. Justice Pitney, speaking for the court, said that the act employs the term "income" in its natural and obvious sense, as importing something distinct from principal or capital and conveying the idea of gain or increase arising from corporate activity.

Mr. Justice Pitney, in the case of Eisner vs. Macomber (252 U.S., 189), again speaking for the court said: "An income may be defined as the gain derived from capital, from labor, or from both combined, provided it be understood to include profit gained through a sale or conversion of capital assets."

For bookkeeping purposes, when stock dividends are declared, the corporation or company acknowledges a liability, in form, to the stockholders, equivalent to the aggregate par value of their stock, evidenced by a "capital stock account." If profits have been made by the corporation during a particular period and not divided, they create additional bookkeeping liabilities under the head of "profit and loss," "undivided profits," "surplus account," etc., or the like.

None of these, however, gives to the stockholders as a body, much less to any one of them, either a claim against the going concern or corporation, for any particular sum of money, or a right to any particular portion of the asset, or any shares sells or until the directors conclude that dividends shall be made a part of the company's assets segregated from the common fund for that purpose. The dividend normally is payable in money and when so paid, then only does the stockholder realize a profit or gain, which becomes his separate property, and thus derive an income from the capital that he has invested. Until that, is done the increased assets belong to the corporation and not to the individual stockholders.

When a corporation or company issues "stock dividends" it shows that the company's accumulated profits have been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution, in money or in kind, should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone said realization, in that the fund represented by the new stock has been transferred from surplus to assets, and no longer is available for actual distribution. The essential and controlling fact is that the stockholder has received nothing out of the company's assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations resulting from employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out of the entire investment. Having regard to the very truth of the matter, to substance and not to form, the stockholder by virtue of the stock dividend has in fact received nothing that answers the definition of an "income." (Eisner vs. Macomber, 252 U.S., 189, 209, 211.)

[VERY IMPORTANT: The stockholder who receives a stock dividend has received nothing but a representation of his increased interest in the capital of the corporation. There has been no separation or segregation of his interest. All the property or capital of the corporation still belongs to the corporation. There has been no separation of the interest of the stockholder from

the general capital of the corporation. The stockholder, by virtue of the stock dividend, has no separate or individual control over the interest represented thereby, further than he had before the stock dividend was issued. He cannot use it for the reason that it is still the property of the corporation and not the property of the individual holder of stock dividend. A certificate of stock represented by the stock dividend is simply a statement of his proportional interest or participation in the capital of the corporation. For bookkeeping purposes, a corporation, by issuing stock dividend, acknowledges a liability in form to the stockholders, evidenced by a capital stock account.

The receipt of a stock dividend in no way increases the money received of a stockholder nor his cash account at the close of the year. It simply shows that there has been an increase in the amount of the capital of the corporation during the particular period, which may be due to an increased business or to a natural increase of the value of the capital due to business, economic, or other reasons. We believe that the Legislature, when it provided for an "income tax," intended to tax only the "income" of corporations, firms or individuals, as that term is generally used in its common acceptation; that is that the income means money received, coming to a person or corporation for services, interest, or profit from investments. We do not believe that the Legislature intended that a mere increase in the value of the capital or assets of a corporation, firm, or individual, should be taxed as "income." Such property can be reached under the ordinary from of taxation.]

Mr. Justice Pitney, in the case of the Einer vs. Macomber, supra, said in discussing the difference between "capital" and "income": "That the fundamental relation of 'capital' to 'income' has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs; the latter as the outlet stream, to be measured by its flow during a period of time." It may be argued that a stockholder might sell the stock dividend which he had acquired. If he does, then he has received, in fact, an income and such income, like any other profit which he realizes from the business, is an income and he may be taxed thereon.

There is a clear distinction between an extraordinary cash dividend, no matter when earned, and stock dividends declared, as in the present case. The one is a disbursement to the stockholder of accumulated earnings, and the corporation at once parts irrevocably with all interest thereon. The other involves no disbursement by the corporation. It parts with nothing to the stockholder. The latter receives, not an actual dividend, but certificate of stock which simply evidences his interest in the entire capital, including such as by investment of accumulated profits has been added to the original capital. They are not income to him, but represent additions to the source of his income, namely, his invested capital. (DeKoven vs. Alsop, 205, Ill., 309; 63 L.R.A. 587). Such a person is in the same position, so far as his income is concerned, as the owner of young domestic animal, one year old at the beginning of the year, which is worth P50 and, which, at the end of the year, and by reason of its growth, is worth P100. The value of his property has increased, but has had an income during the year? It is true that he had taxable property at the beginning of the year of the value of P50, and the same taxable property at another period, of the value of P100, but he has had no income in the common acceptation of that word. The increase in the value of the property should be taken account of on the tax duplicate for the purposes of ordinary taxation, but not as income for he has had none.

The question whether stock dividends are income, or capital, or assets has frequently come before the courts in another form — in cases of inheritance. A is a stockholder in a large corporation. He dies leaving a will by the terms of which he give to B during his lifetime the "income" from said stock, with a further provision that C shall, at B's death, become the owner of his share in the corporation. During B's life the corporation issues a stock dividend. Does the stock dividend belong to B as an income, or does it finally belong to C as a part of his share in the capital or assets of the corporation, which had been left to him as a remainder by A? While there has been some difference of opinion on

that question, we believe that a great weight of authorities hold that the stock dividend is capital or assets belonging to C and not an income belonging to B. In the case of D'Ooge vs. Leeds (176 Mass., 558, 560) it was held that stock dividends in such cases were regarded as capital and not as income(Gibbons vs. Mahon, 136 U.S., 549.)

In the case of Gibbson vs. Mahon, supra, Mr. Justice Gray said: "The distinction between the title of a corporation, and the interest of its members or stockholders in the property of the corporation, is familiar and well settled. The ownership of that property is in the corporation, and not in the holders of shares of its stock. The interest of each stockholder consists in the right to a proportionate part of the profits whenever dividends are declared by the corporation, during its existence, under its charter, and to a like proportion of the property remaining, upon the termination or dissolution of the corporation, after payment of its debts." (Minot vs. Paine, 99 Mass., 101; Greeff vs. Equitable Life Assurance Society, 160 N. Y., 19.) In the case of Dekoven vs. Alsop (205 Ill ,309, 63 L. R. A. 587) Mr. Justice Wilkin said: "A dividend is defined as a corporate profit set aside, declared, and ordered by the directors to be paid to the stockholders on demand or at a fixed time. Until the dividend is declared, these corporate profits belong to the corporation, not to the stockholders, and are liable for corporate indebtedness.

There is a clear distinction between an extraordinary cash dividend, no matter when earned, and stock dividends declared. The one is a disbursement to the stockholders of accumulated earning, and the corporation at once parts irrevocably with all interest thereon. The other involves no disbursement by the corporation. It parts with nothing to the stockholders.

The latter receives, not an actual dividend, but certificates of stock which evidence in a new proportion his interest in the entire capital. When a cash becomes the absolute property of the stockholders and cannot be reached by the creditors of the corporation in the absence of fraud. A stock dividend however, still being the property of the corporation and not the stockholder, it may be reached by an execution against the corporation, and sold as a part of the property of the corporation. In such a case, if all the property of the corporation is sold, then the stockholder certainly could not be charged with having received an income by virtue of the issuance of the stock dividend. Until the dividend is declared and paid, the corporate profits still belong to the corporation, not to the stockholders, and are liable for corporate indebtedness. The rule is well established that cash dividend, whether large or small, are regarded as "income" and all stock dividends, as capital or assets (Cook on Corporation, Chapter 32, secs. 534, 536; Davis vs. Jackson, 152 Mass., 58; Mills vs. Britton, 64 Conn., 4; 5 Am., and Eng. Encycl. of Law, 2d ed., p. 738.)

If the ownership of the property represented by a stock dividend is still in the corporation and to in the holder of such stock, then it is difficult to understand how it can be regarded as income to the stockholder and not as a part of the capital or assets of the corporation. (Gibbsons vs. Mahon, supra.)

the stockholder has received nothing but a representation of an interest in the property of the corporation and, as a matter of fact, he may never receive anything, depending upon the final outcome of the business of the corporation. The entire assets of the corporation may be consumed by mismanagement, or eaten up by debts and obligations, in which case the holder of the stock dividend will never have received an income from his investment in the corporation. A corporation may be solvent and prosperous today and issue stock dividends in representation of its increased assets, and tomorrow be absolutely insolvent by reason of changes in business conditions, and in such a case the stockholder would have received nothing from his investment. In such a case, if the holder of the stock dividend is required to pay an income tax on the same, the result would be that he has paid a tax upon an income which he never received. Such a conclusion is absolutely contradictory to the idea of an income.

[VERY IMPORTANT: An income subject to taxation under the law must be an actual income and not a promised or prospective income.]

The appelle argues that there is nothing in section 25 of Act No 2833 which contravenes the provisions of the Jones Law. That may be admitted. He further argues that the Act of Congress (U.S. Revenue Act of 1918) expressly authorized the Philippine Legislatures to provide for an income tax. That fact may also be admitted. But a careful reading of that Act will show that, while it permitted a tax upon income, the same provided that income shall include gains, profits, and income derived from salaries, wages, or compensation for personal services, as well as from interest, rent, dividends, securities, etc. The appellee emphasizes the "income from dividends." Of course, income received as dividends is taxable as an income but an income from "dividends" is a very different thing from receipt of a "stock dividend." One is an actual receipt of profits; the other is a receipt of a representation of the increased value of the assets of corporation.

In all of the foregoing argument we have not overlooked the decisions of a few of the courts in different parts of the world, which have reached a different conclusion from the one which we have arrived at in the present case. Inasmuch, however, as appeals may be taken from this court to the Supreme Court of the United States, we feel bound to follow the same doctrine announced by that court.

Having reached the conclusion, supported by the great weight of the authority, that "stock dividends" are NOT "income," the same cannot be taxed under that provision of Act No. 2833 which provides for a tax upon income. Under the guise of an income tax, property which is not an income cannot be taxed. When the assets of a corporation have increased so as to justify the issuance of a stock dividend, the increase of the assets should be taken account of the Government in the ordinary tax duplicates for the purposes of assessment and collection of an additional tax. For all of the foregoing reasons, we are of the opinion, and so decide, that the judgment of the lower court should be revoked, and without any finding as to costs, it is so ordered.

Araullo, C.J. Avanceña, Villamor and Romualdez, JJ., concur.

U.S. Supreme Court

Doyle v. Mitchell Bros. Co., 247 U.S. 179 (1918)

Doyle v. Mitchell Brothers Company

No. 492

Argued March 4, 5, 6, 1918

Decided May 20, 1918

247 U.S. 179

CERTIORARI TO THE CIRCUIT COURT OF APPEALS

FOR THE SIXTH CIRCUIT

Syllabus

The purpose of the Corporation Tax Act of August 5, 1909, c. 6, 36 Stat. 11, 112, 38, is not to tax property as such, or the mere conversion of property, but to tax the conduct of the business of corporations organized for profit by a measure based upon the gainful returns from their business operations and property from the time the act took effect.

The act employs the term "income" in its natural and obvious sense, as importing something distinct from principal or capital, and conveying the idea of gain or increase arising from corporate activities.

While a conversion of capital may result in income, in the sense of the act, where the proceeds include an increment of value, such is not the case where the increment existed when the act took effect.

In distinguishing preexisting capital from income subject to the act, it is a mere question of method whether a deduction be made from gross receipts in ascertaining gross income, or from gross income, by way of depreciation, in ascertaining net income.

Before the Corporation Tax Act, a lumber company bought timber land to supply its mills, and after the act, it manufactured part of the timber into lumber, which it sold.

Held that the amount by which the timber so used had increased in value between the date of purchase and the effective date of the act was not an element of income to be considered in computing the tax.

The principle upon which the removal of minerals by mining companies has been held not to produce a depreciation within the meaning of the act is inapplicable to the case of a company engaged in the business of manufacturing and selling lumber from timber supplied by it own timber lands, and which sell the lands incidentally after the timber is removed.

The income is to be determined from the actual fact, as to which the corporate books are only evidential.

MR. JUSTICE PITNEY delivered the opinion of the Court.

This was an action to recover from the Collector additional taxes assessed against the respondent under the Corporation Excise Tax Act of August 5, 1909, c. 6, 36 Stat. 11, 112, § 38, and paid under protest.

The district court gave judgment for the plaintiff CORPORATION, which was affirmed by the circuit court of appeals (225 F. 437; 235 F. 686), and the case comes here on certiorari.

FACTS:

Mitchel Bros. is a lumber manufacturing corporation which operates its own mills, manufactures into lumber therein its own stumpage, sells the lumber in the market, and from these sales and sales of various byproducts makes its profits, declares its dividends, and creates its surplus. I

t sells its stumpage lands, so-called, after the timber is cut and removed. Its sole business is as described; it is not a real estate trading corporation.

Plaintiff acquired certain timber lands in 1903, at approximately $20 per acre.

In 1908, the market value of the timber land increased to approximately $40 per acre.

The company made no entry upon its books representing this increase, but each year entered as a profit the difference between the original cost of the timber cut and the sums received for the manufactured product, less the cost of manufacture.

After the passage of the Excise Tax Act, and preparatory to making a return of income for the year 1909, the company revalued its timber stumpage as of December 31, 1908 at approximately $40 per acre. The good faith and accuracy of this valuation are not in question, but the figures representing it never were entered in the corporate books.

Under the act, the company made a return for each of the years 1909, 1910, 1911, and 1912, and in each instance deducted from its gross receipts the market value, as of December 31, 1908, of the stumpage cut and converted during the year covered by the tax. There appears to have been no change in its market value during these years.

The Commissioner of Internal Revenue having allowed a deduction of the cost of the timber in 1903 and refused to allow the difference between that cost and the fair market value of the timber on December 31, 1908, the question is whether this difference (made the basis of the additional taxes) was income for the years in which it was converted into money, within the meaning of the act.

Other items are involved in the case, arising from the sale of certain stump lands, certain byproducts, and a parcel of real estate, but they raise no different question from that which arises upon the valuation of the stumpage, and need not be further mentioned.

The act became effective January 1, 1909, and provided for the annual payment by every domestic corporation "organized for profit and having a capital stock represented by shares" of an excise tax "equivalent to one percentum upon the entire net income over and above five thousand dollars received by it from all sources during such year," with exceptions not now material.

It declared that such net income should be ascertained by deducting from the gross income received within the year from all sources the expenses paid within the year out of income in the maintenance and operation of business and property, including rentals and the like; losses sustained within the year and not compensated by insurance or otherwise, including a reasonable allowance for depreciation of property; interest paid within the year to a limited extent; taxes, and amounts received within the year as dividends upon stock of other corporations subject to the same tax.

In the case of a corporation organized under the laws of a foreign country, the net income was to be ascertained by taking into account the gross income received within the year "from business transacted and capital invested within the United States and any of its territories, Alaska, and the District of Columbia," with deductions for expenses of maintenance and operation, business losses, interest, and taxes, all referable to that portion of its business transacted and capital invested within the United States, etc.

An examination of these and other provisions of the act makes it plain that the legislative purpose was not to tax property as such, or the mere conversion of property, but to tax the conduct of the business of corporations organized for profit by a measure based upon the gainful returns from their business operations and property from the time the act took effect.

As was pointed out in Flint v. Stone Tracy Co. , the tax was imposed

"not upon the franchises of the corporation irrespective of their use in business, nor upon the property of the corporation, but upon the doing of corporate or insurance business and with respect to the carrying on thereof,"

an exposition that has been consistently adhered to. McCoach v. Minehill R. Co.,228 U. S. 295, 228 U. S. 300; United States v. Whitridge,231 U. S. 144, 231 U. S. 147; Anderson v. Forty-Two Broadway,239 U. S. 69, 239 U. S. 72.

When we come to apply the act to gains acquired through an increase in the value of capital assets acquired before and converted into money after the taking effect of the act, questions of difficulty are encountered. The suggestion that the entire proceeds of the conversion should be still treated as the same capital, changed only in form and containing no element of income, although including an increment of value, we reject at once as inconsistent with the general purpose of the act. Selling for profit is too familiar a business transaction to permit us to suppose that it was intended to be omitted from consideration in an act for taxing the doing of business in corporate form upon the basis of the income received "from all sources."

Starting from this point, the learned Solicitor General has submitted an elaborate argument in behalf of the government, based in part upon theoretical definitions of "capital," "income," "profits," etc., and in part upon expressions quoted from our opinions in Flint v. Stone Tracy Co., and Anderson v. Forty-Two Broadway, , with the object of showing that a conversion of capital into money always produces income, and that, for the purposes of the present case, the words "gross income" are equivalent to "gross receipts," the insistence being that the entire proceeds of a conversion of capital assets should be treated as gross income, and that, by deducting the mere cost of such assets, we arrive at net income.

The cases referred to throw little light upon the present matter, and the expressions quoted from the opinions were employed by us with reference to questions wholly remote from any that is here presented.

The formula that the entire receipts derived from a conversion of capital assets after deducting cost value must be treated as net income, so far as it is applied to a conversion of assets acquired before the act took effect and so as to tax as income any increased value that accrued before that date, finds NO support in either the letter or the spirit of the act, and brings the former into incongruity with the latter.

If the gross receipts upon such a conversion are to be treated as gross income, what authority have we for deducting either the cost or the previous market value of the assets converted in order to arrive at net income? The deductions specifically authorized are only such as expenses of maintenance and operation of the business and property, rentals, uncompensated losses, depreciation, interest, and taxes. There is no express provision that even allows a merchant to deduct the cost of the goods that he sells.

[VERY IMPORTANT: Yet it is plain, we think, that, by the true intent and meaning of the act, the entire proceeds of a mere conversion of capital assets were NOT to be treated as income.]

Page 247 U. S. 185

[VERY IMPORTANT: Whatever difficulty there may be about a precise and scientific definition of "income," it imports, as used here, something entirely distinct from principal or capital either as a subject of taxation or as a measure of the tax, conveying, rather, the idea of gain or increase arising from corporate activities].

As was said in Stratton's Independence v. Howbert,: "Income may be defined as the gain derived from capital, from labor, or from both combined."

[VERY IMPORTANT: It cannot be said that a conversion of capital assets invariably produces income. If sold at less than cost, it produces rather loss or outgo. Nevertheless, in many if not in most cases, there results a gain that properly may be accounted as a part of the "gross income" received "from all sources;" and by applying to this the authorized deductions we arrive at "net income." In order to determine whether there has been gain or loss, and the amount of the gain if any, we must withdraw from the gross proceeds an amount sufficient to restore the capital value that existed at the commencement of the period under consideration.]

This has been recognized from the beginning by the administrative officers of the government. Shortly after the passage of the act, and before the time (March 1, 1910) for making the first returns of income, the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, promulgated Regulations No. 31, under date December 3, 1909, for the guidance of collectors and other subordinate officers in the performance of their duties under the act. These prescribed, with respect to manufacturing companies, that gross income should consist of the difference between the price received for the goods as sold and the cost of such goods as manufactured, cost to be "ascertained by an addition of a charge to the account of goods asmanufactured during the year of the sum of the inventory at beginning of the year and a credit to the account of the sum of the inventory at the end of the year."

In the case of mercantile companies, gross income was to be the "amount ascertained through inventory, or its equivalent, which shows the difference between the price received for goods sold

and the cost of goods purchased during the year, with an addition of a charge to the account of the sum of the inventory at beginning of the year and a credit to the account of the sum of the inventory at the end of the year."

And as to miscellaneous corporations, gross income was to be "the gross revenue derived from the operation and management of the business and property of the corporation," with all income derived from other sources. The matter of income arising from a profitable sale of capital assets was dealt with specifically in such a way as to limit the tax to income arising after the effective date of the act. This was done by adopting the rule that an advance in value arising during a period of years should be so adjusted that only so much as properly was attributable to the time subsequent to January 1, 1909 (December 31, 1908, would have been more precise) should be subjected to the tax. [Footnote 2] Subsequent treasury regulations, promulgated from time to time adhered to the same rule with respect to lands bought prior to January 1, 1909, and sold during a subsequent year, prescribing, however, that the profits, when not otherwise accurately determinable, should be prorated according to the time elapsed before and after the act took effect, and gave to it an application especially pertinent here, one of the regulations reading:

"The mere removal of timber by cutting from timber lands, unless the timber is otherwise disposed of through sales or plant operations, is considered simply a change in form of assets. If said timber is disposed of through sales or otherwise, it is to be accounted for in accordance with regulations governing disposition of capital and other assets."

In our opinion, these regulations correctly interpret the act in its application to the facts of the present case. When the act took effect, plaintiff's timber lands, with whatever value they then possessed, were a part of its capital assets, and a subsequent change of form by conversion into money did not change the essence.

Their increased value since purchase was NOT in any proper sense the result of the operation and management of the business or property of the corporation while the act as in force. Nor is the result altered by the mere fact that the increment of value had not been entered upon plaintiff's books of account. Such books are no more than evidential, being neither indispensable nor conclusive. The decision must rest upon the actual facts, which in the present case are not in dispute.

The plaintiff, in making up its income tax returns for the years 1909, 1910, 1911, and 1912, deducted from its gross receipts the admittedly accurate valuation as of December 31, 1908, of the stumpage cut and converted during the year covered by the tax. There having been no change in market values during these years, the deduction did but restore to the capital in money that which had been withdrawn in stumpage cut, leaving the aggregate of capital neither increased nor decreased, and leaving the residue of the gross receipts to represent the gain realized by the conversion, so far as that gain arose while the act was in effect. This was in accordance with the true intent and meaning of the act.

It may be observed that it is a mere question of methods, not affecting the result, whether the amount necessary to be withdrawn in order to preserve capital intact should be deducted from gross receipts in the process of ascertaining gross income or should be deducted from gross income in the form of a depreciation account in the process of determining net income. In either case, the object is to distinguish capital previously existing from income taxable under the act.

There is only a superficial analogy between this case and the case of an allowance claimed for depreciation of a mining property through the removal of minerals, since we have held that owing to

the peculiar nature of mining property its partial exhaustion attributable to the removal of ores cannot be regarded as depreciation within the meaning of the act.

It should be added that, in this case, no question is raised as to whether, in apportioning the profits derived from a disposition of capital assets acquired before and converted after the act took effect, the division should be pro rata, according to the time elapsed, or should be based upon an inventory taken as of December 31, 1908. Plaintiffs, in accordance with Treasury Regulations No. 31, T.D. 1578,

adopted the latter method, and the government makes no contention as to the accuracy of the result thereby reached, under the stipulated facts, if our construction of the act be correct.

Judgment affirmed.

[Footnote 1]

The valuations were based upon the quantity of standing timber at certain prices per thousand feet for the different varieties. The approximate acreage equivalent is employed for convenience.

[Footnote 2]

Extract from Treasury Regulations No. 31, issued December 3, 1909.

"Sale of Capital Assets. -- In ascertaining income derived from the sale of capital assets, if the assets were acquired subsequent to January 1, 1909, the difference between the selling price and the buying price shall constitute an item of gross income to be added to or subtracted from gross income according to whether the selling price was greater or less than the buying price. If the capital assets were acquired prior to January 1, 1909, the amount of increment or depreciation representing the difference between the selling and buying price is to be adjusted so as to fairly determine the proportion of the loss or gain arising subsequent to January 1, 1909, and which proportion shall be deducted from or added to the gross income for the year in which the sale was made."

Official Supreme Court case law is only found in the print version of the United States Reports. Justia case law is provided for general informational purposes only, and may not reflect current legal developments, verdicts or settlements. We make no warranties or guarantees about the accuracy, completeness, or adequacy of the information contained on this site or information linked to from this site. Please check official sources.

U.S. Supreme Court

Eisner v. Macomber, 252 U.S. 189 (1920)

Eisner v. Macomber

No. 318

Argued April 16, 1919

Restored to docket for reargument May 19, 1919

Reargued October 17, 20, 1919

Decided March 8, 1920

252 U.S. 189

ERROR TO THE DISTRICT COURT OF THE UNITED STATES

FOR THE SOUTHERN DISTRICT OF NEW YORK

Syllabus

Congress was not empowered by the Sixteenth Amendment to tax, as income of the stockholder, without apportionment, a stock dividend made lawfully and in good faith against profits accumulated by the corporation since March 1, 1913.

The Revenue Act of September 8, 1916, c. 463, 39 Stat. 756, plainly evinces the purpose of Congress to impose such taxes, and is to that extent in conflict with Art. I, § 2, cl. 3, and Art. I, § 9, cl. 4, of the Constitution.

These provisions of the Constitution necessarily limit the extension, by construction, of the Sixteenth Amendment.

What is or is not "income" within the meaning of the Amendment must be determined in each case according to truth and substance, without regard to form.

Income may be defined as the gain derived from capital, from labor, or from both combined, including profit gained through sale or conversion of capital

[VERY IMPORTANT: Mere growth or increment of value in a capital investment is not income; income is essentially a gain or profit, in itself, of exchangeable value, proceeding from capital, severed from it, and derived or received by the taxpayer for his separate use, benefit, and disposal. Id.]

A stock dividend, evincing merely a transfer of an accumulated surplus to the capital account of the corporation, takes nothing from the property of the corporation and adds nothing to that of the shareholder; a tax on such dividends is a tax an capital increase, and not on income, and, to be valid

under the Constitution, such taxes must be apportioned according to population in the several states. P. 252 U. S. 208.

Affirmed.

MR. JUSTICE PITNEY delivered the opinion of the Court.

ISSUE:

Whether or not, by virtue of the Sixteenth Amendment, Congress has the power to tax, as income of the stockholder and without apportionment, a stock dividend made lawfully and in good faith against profits accumulated by the corporation since March 1, 1913.

FACTS:

It arises under the Revenue Act of September 8, 1916, 39 Stat. 756 et seq., which, in our opinion (notwithstanding a contention of the government that will be

noticed), plainly evinces the purpose of Congress to tax stock dividends as income. *

The Standard Oil Company of California, a corporation of that state, out of an authorized capital stock of $100,000,000, had shares of stock outstanding, par value $100 each, amounting in round figures to $50,000,000. In addition, it had surplus and undivided profits invested in plant, property, and business and required for the purposes of the corporation, amounting to about $45,000,000, of which about $20,000,000 had been earned prior to March 1, 1913, the balance thereafter. In January, 1916, in order to readjust the capitalization, the board of directors decided to issue additional shares sufficient to constitute a stock dividend of 50 percent of the outstanding stock, and to transfer from surplus account to capital stock account an amount equivalent to such issue. Appropriate resolutions were adopted, an amount equivalent to the par value of the proposed new stock was transferred accordingly, and the new stock duly issued against it and divided among the stockholders.

Defendant in error, being the owner of 2,200 shares of the old stock, received certificates for 1, 100 additional shares, of which 18.07 percent, or 198.77 shares, par value $19,877, were treated as representing surplus earned between March 1, 1913, and January 1, 1916. She was called upon to pay, and did pay under protest, a tax imposed under the Revenue Act of 1916, based upon a supposed income of $19,877 because of the new shares, and, an appeal to the Commissioner of Internal Revenue having been disallowed, she brought action against the Collector to recover the tax. In her complaint, she alleged the above facts and contended that, in imposing such a tax the Revenue Act of 1916 violated article 1, § 2, cl. 3, and Article I, § 9, cl. 4, of the Constitution of the United States, requiring direct taxes to be apportioned according to population, and that the stock dividend was not income within the meaning of the Sixteenth Amendment. A general demurrer to the complaint was overruled upon the authority of Towne v. Eisner,245 U. S. 418, and, defendant having failed to plead further, final judgment went against him. To review it, the present writ of error is prosecuted.

We are constrained to hold that the judgment of the district court must be affirmed, first, because the question at issue is controlled by Towne v. Eisner, supra; secondly, because a reexamination of the question with the additional light thrown upon it by elaborate arguments has confirmed the view that the underlying ground of that decision is sound, that it disposes of the question here presented, and that other fundamental considerations lead to the same result.

In Towne v. Eisner, the question was whether a stock dividend made in 1914 against surplus earned prior to January 1, 1913, was taxable against the stockholder under the Act of October 3, 1913, c. 16, 38 Stat. 114, 166, which provided (§ B, p. 167) that net income should include "dividends," and also "gains or profits and income derived from any source whatever."

Suit having been brought by a stockholder to recover the tax assessed against him by reason of the dividend, the district court sustained a demurrer to the complaint. 242 F. 702. The court treated the construction of the act as inseparable from the interpretation of the Sixteenth Amendment; and, having referred to Pollock v. Farmers' Loan & Trust Co.,158 U. S. 601, and quoted the Amendment, proceeded very properly to say (p. 704):

"It is manifest that the stock dividend in question cannot be reached by the Income Tax Act and could not, even though Congress expressly declared it to be taxable as income, unless it is in fact income."

It declined, however, to accede to the contention that, in Gibbons v. Mahon,136 U. S. 549, "stock dividends" had received a definition sufficiently clear to be controlling, treated the language of this Court in that case as obiter dictum in respect of the matter then before it (p. 706), and examined the question as res nova, with the result stated. When the case came here, after overruling a motion to dismiss made by the government upon the ground that the only question involved was the construction of the statute, and not its constitutionality, we dealt upon the merits with the question of construction only, but disposed of it upon consideration of the essential nature of a stock dividend disregarding the fact that the one in question was based upon surplus earnings that accrued before the Sixteenth Amendment took effect. Not only so, but we rejected the reasoning of the district court, saying (245 U.S. 245 U. S. 426):

"Notwithstanding the thoughtful discussion that the case received below we cannot doubt that the dividend was capital as well for the purposes of the Income Tax Law as for distribution between tenant for life and remainderman. What was said by this Court upon the latter question is equally true for the former."

"A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders. Its property is not diminished, and their interests are not increased. . . . The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones."

"Gibbons v. Mahon,136 U. S. 549, 136 U. S. 559-560. In short, the corporation is no poorer and the stockholder is no richer than they were before. Logan County v. United States,169 U. S. 255, 169 U. S. 261. If the plaintiff gained any small advantage by the change, it certainly was not an advantage of $417,450, the sum upon which he was taxed. . . . What has happened is that the plaintiff's old certificates have been split up in effect and have diminished in value to the extent of the value of the new."

This language aptly answered not only the reasoning of the district court, but the argument of the Solicitor General in this Court, which discussed the essential nature of a stock dividend. And if, for the reasons thus expressed, such a dividend is not to be regarded as "income" or "dividends" within the meaning of the Act of 1913, we are unable to see how it can be brought within the meaning of "incomes" in the Sixteenth Amendment, it being very clear that Congress intended in that act to exert its power to the extent permitted by the amendment. In Towne v. Eisner, it was not contended that any construction of the statute could make it narrower than the constitutional grant; rather the contrary.

The fact that the dividend was charged against profits earned before the Act of 1913 took effect, even before the amendment was adopted, was neither relied upon nor alluded to in our consideration of the merits in that case. Not only so, but had we considered that a stock dividend constituted income in any true sense, it would have been held taxable under the Act of 1913 notwithstanding it was based upon profits earned before the amendment.

We ruled at the same term, in Lynch v. Hornby,247 U. S. 339, that a cash dividend extraordinary in amount, and in Peabody v. Eisner,247 U. S. 347, that a dividend paid in stock of another company, were taxable as income although based upon earnings that accrued before adoption of the amendment. In the former case, concerning "corporate profits that accumulated before the act took effect," we declared:

"Just as we deem the legislative intent manifest to tax the stockholder with respect to such accumulations only if and when, and to the extent that, his interest in them comes to fruition as income, 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 preexisting surplus. . . . 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."

In Peabody v. Eisner,247 U. S. 349, 247 U. S. 350, we observed that the decision of the district court in Towne v. Eisner had been reversed

"only upon the ground that it related to a stock dividend which in fact took nothing from the property of the corporation and added nothing to the interest of the shareholder, but merely changed the evidence which represented that interest,"

and we distinguished the Peabody case from the Towne case upon the ground that "the dividend of Baltimore & Ohio shares was not a stock dividend but a distribution in specie of a portion of the assets of the Union Pacific."

Therefore, Towne v. Eisner cannot be regarded as turning upon the point that the surplus accrued to the company before the act took effect and before adoption of the amendment.

And what we have quoted from the opinion in that case cannot be regarded as obiter dictum, it having furnished the entire basis for the conclusion reached. We adhere to the view then expressed, and might rest the present case there not because that case in terms decided the constitutional question, for it did not, but because the conclusion there reached as to the essential nature of a stock dividend necessarily prevents its being regarded as income in any true sense.

Nevertheless, in view of the importance of the matter, and the fact that Congress in the Revenue Act of 1916 declared (39 Stat. 757) that a "stock dividend shall be considered income, to the amount of its cash value," we will deal at length with the constitutional question, incidentally testing the soundness of our previous conclusion.

The Sixteenth Amendment must be construed in connection with the taxing clauses of the original Constitution and the effect attributed to them before the amendment was adopted. InPollock v. Farmers' Loan & Trust Co.,158 U. S. 601, under the Act of August 27, 1894, c. 349, § 27, 28 Stat. 509, 553, it was held that taxes upon rents and profits of real estate and upon returns from

investments of personal property were in effect direct taxes upon the property from which such income arose, imposed by reason of ownership, and that Congress could not impose such taxes without apportioning them among the states according to population, as required by Article I, § 2, cl. 3, and § 9, cl. 4, of the original Constitution.

Afterwards, and evidently in recognition of the limitation upon the taxing power of Congress thus determined, the Sixteenth Amendment was adopted, in words lucidly expressing the object to be accomplished:

"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."

As repeatedly held, this did not extend the taxing power to new subjects, but merely removed the necessity which otherwise might exist for an apportionment among the states of taxes laid on income.

A proper regard for its genesis, as well as its very clear language, requires also that this amendment shall not be extended by loose construction, so as to repeal or modify, except as applied to income, those provisions of the Constitution that require an apportionment according to population for direct taxes upon property, real and personal. This limitation still has an appropriate and important function, and is not to be overridden by Congress or disregarded by the courts.

In order, therefore, that the clauses cited from Article I of the Constitution may have proper force and effect, save only as modified by the amendment, and that the latter also may have proper effect,

it becomes essential to distinguish between what is and what is not "income," as the term is there used, and to apply the distinction, as cases arise, according to truth and substance, without regard to form. Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised.

[VERY IMPORTANT: The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time.

For the present purpose, we require only a clear definition of the term "income,"as used in common speech, in order to determine its meaning in the amendment, and, having formed also a correct judgment as to the nature of a stock dividend, we shall find it easy to decide the matter at issue.

After examining dictionaries in common use (Bouv. L.D.; Standard Dict.; Webster's Internat. Dict.; Century Dict.), we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909 (Stratton's Independence v. Howbert,231 U. S. 399,231 U. S. 415; Doyle v. Mitchell Bros. Co.,247 U. S. 179, 247 U. S. 185), "Income may be defined as the gain derived from capital, from labor, or from both combined," provided it be understood to include profit gained through a sale or conversion of capital assets, to which it was applied in the Doyle case, pp. 247 U. S. 183-185.

Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word "gain," which was extended to

include a variety of meanings; while the significance of the next three words was either overlooked or misconceived.

[VERY IMPORTANT: "Derived from capital;" "the gain derived from capital," etc. Here, we have the essential matter: not a gain accruing to capital; not 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 or employed, and coming in, being "derived" -- that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal -- that is income derived from property. Nothing else answers the description.

The same fundamental conception is clearly set forth in the Sixteenth Amendment -- "incomes,from whatever source derived" -- the essential thought being expressed with a conciseness and lucidity entirely in harmony with the form and style of the Constitution.

Can a stock dividend, considering its essential character, be brought within the definition? To answer this, regard must be had to the nature of a corporation and the stockholder's relation to it. We refer, of course, to a corporation such as the one in the case at bar, organized for profit, and having a capital stock divided into shares to which a nominal or par value is attributed.

[VERY IMPORTANT: Certainly the interest of the stockholder is a capital interest, and his certificates of stock are but the evidence of it. They state the number of shares to which he is entitled and indicate their par value and how the stock may be transferred. They show that he or his assignors, immediate or remote, have contributed capital to the enterprise, that he is entitled to a corresponding interest proportionate to the whole, entitled to have the property and business of the company devoted during the corporate existence to attainment of the common objects, entitled to vote at stockholders' meetings, to receive dividends out of the corporation's profits if and when declared, and, in the event of liquidation, to receive a proportionate share of the net assets, if any, remaining after paying creditors. Short of liquidation, or until dividend declared, he has no right to withdraw any part of either capital or profits from the common enterprise; on the contrary, his interest pertains not to any part, divisible or indivisible, but to the entire assets, business, and affairs of the company. Nor is it the interest of an owner in the assets themselves, since the corporation has full title, legal and equitable, to the whole. The stockholder has the right to have the assets employed in the enterprise, with the incidental rights mentioned; but, as stockholder, he has no right to withdraw, only the right to persist, subject to the risks of the enterprise, and looking only to dividends for his return.

If he desires to dissociate himself from the company, he can do so only by disposing of his stock.

For bookkeeping purposes, the company acknowledges a liability in form to the stockholders equivalent to the aggregate par value of their stock, evidenced by a "capital stock account." If profits have been made and not divided, they create additional bookkeeping liabilities under the head of "profit and loss," "undivided profits," "surplus account," or the like.

None of these, however, gives to the stockholders as a body, much less to any one of them, either a claim against the going concern for any particular sum of money or a right to any particular portion of the assets or any share in them unless or until the directors conclude that dividends shall be made and a part of the company's assets segregated from the common fund for the purpose. The dividend normally is payable in money, under exceptional circumstances in some other divisible property, and when so paid, then only (excluding, of course, a possible advantageous sale of his stock or winding-up of the company) does the stockholder realize

a profit or gain which becomes his separate property, and thus derive income from the capital that he or his predecessor has invested.

In the present case, the corporation had surplus and undivided profits invested in plant, property, and business, and required for the purposes of the corporation, amounting to about $45,000,000, in addition to outstanding capital stock of $50,000,000. In this, the case is not extraordinary. The profits of a corporation, as they appear upon the balance sheet at the end of the year, need not be in the form of money on hand in excess of what is required to meet current liabilities and finance current operations of the company. Often, especially in a growing business, only a part, sometimes a small part, of the year's profits is in property capable of division, the remainder having been absorbed in the acquisition of increased plant, equipment, stock in trade, or accounts receivable, or in decrease of outstanding liabilities.

When only a part is available for dividends, the balance of the year's profits is carried to the credit of undivided profits, or surplus, or some other account having like significance. If thereafter the company finds itself in funds beyond current needs, it may declare dividends out of such surplus or undivided profits; otherwise it may go on for years conducting a successful business, but requiring more and more working capital because of the extension of its operations, and therefore unable to declare dividends approximating the amount of its profits.

Thus, the surplus may increase until it equals or even exceeds the par value of the outstanding capital stock. This may be adjusted upon the books in the mode adopted in the case at bar -- by declaring a "stock dividend."

This, however, is no more than a book adjustment, in essence -- not a dividend, but rather the opposite; no part of the assets of the company is separated from the common fund, nothing distributed except paper certificates that evidence an antecedent increase in the value of the stockholder's capital interest resulting from an accumulation of profits by the company, but profits so far absorbed in the business as to render it impracticable to separate them for withdrawal and distribution.

In order to make the adjustment, a charge is made against surplus account with corresponding credit to capital stock account, equal to the proposed "dividend;" the new stock is issued against this and the certificates delivered to the existing stockholders in proportion to their previous holdings. This, however, is merely bookkeeping that does not affect the aggregate assets of the corporation or its outstanding liabilities; it affects only the form, not the essence, of the "liability" acknowledged by the corporation to its own shareholders, and this through a readjustment of accounts on one side of the balance sheet only, increasing "capital stock" at the expense of "surplus"; it does not alter the preexisting proportionate interest of any stockholder or increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they stood before. The new certificates simply increase the number of the shares, with consequent dilution of the value of each share.

[VERY IMPORTANT: A "stock dividend" shows that the company's accumulated profits have been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution in money or in kind should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone such realization, in that the fund represented by the new stock has been transferred from surplus to capital, and no longer is available for actual distribution.

[VERY IMPORTATANT: The essential and controlling fact is that the stockholder has received nothing out of the company's assets for his separate use and benefit; on the contrary, every

dollar of his original investment, together with whatever accretions and accumulations have resulted from employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance and not to form, he has received nothing that answers the definition of income within the meaning of the Sixteenth Amendment.

Being concerned only with the true character and effect of such a dividend when lawfully made, we lay aside the question whether, in a particular case, a stock dividend may be authorized by the local law governing the corporation, or whether the capitalization of profits may be the result of correct judgment and proper business policy on the part of its management, and a due regard for the interests of the stockholders. And we are considering the taxability of bona fide stock dividends only.

We are clear that not only does a stock dividend really take nothing from the property of the corporation and add nothing to that of the shareholder, but that the antecedent accumulation of profits evidenced thereby, while indicating that the shareholder is the richer because of an increase of his capital, at the same time shows he has not realized or received any income in the transaction.

It is said that a stockholder may sell the new shares acquired in the stock dividend, and so he may, if he can find a buyer. It is equally true that, if he does sell, and in doing so realizes a profit, such profit, like any other, is income, and, so far as it may have arisen since the Sixteenth Amendment, is taxable by Congress without apportionment. The same would be true were he to sell some of his original shares at a profit. But if a shareholder sells dividend stock, he necessarily disposes of a part of his capital interest, just as if he should sell a part of his old stock, either before or after the dividend. What he retains no longer entitles him to the same proportion of future dividends as before the sale. His part in the control of the company likewise is diminished. Thus, if one holding $60,000 out of a total $100,000 of the capital stock of a corporation should receive in common with other stockholders a 50 percent stock dividend, and should sell his part, he thereby would be reduced from a majority to a minority stockholder, having six-fifteenths instead of six-tenths of the total stock outstanding. A corresponding and proportionate decrease in capital interest and in voting power would befall a minority holder should he sell dividend stock, it being in the nature of things impossible for one to dispose of any part of such an issue without a proportionate disturbance of the distribution of the entire capital stock and a like diminution of the seller's comparative voting power -- that "right preservative of rights" in the control of a corporation.

Yet, without selling, the shareholder, unless possessed of other resources, has not the wherewithal to pay an income tax upon the dividend stock. Nothing could more clearly show that to tax a stock dividend is to tax a capital increase, and not income, than this demonstration that, in the nature of things, it requires conversion of capital in order to pay the tax.

Throughout the argument of the government, in a variety of forms, runs the fundamental error already mentioned -- a failure to appraise correctly the force of the term "income" as used in the Sixteenth Amendment, or at least to give practical effect to it. Thus, the government contends that the tax "is levied on income derived from corporate earnings," when in truth the stockholder has "derived" nothing except paper certificates, which, so far as they have any effect, deny him present participation in such earnings. It contends that the tax may be laid when earnings "are received by the stockholder," whereas he has received none; that the profits are "distributed by means of a stock dividend," although a stock dividend distributes no profits; that, under the Act of 1916, "the tax is on the stockholder's share in corporate earnings," when in truth a stockholder has no such share, and receives none in a stock dividend; that "the profits are segregated from his former capital, and he

has a separate certificate representing his invested profits or gains," whereas there has been no segregation of profits, nor has he any separate certificate representing a personal gain, since the certificates, new and old, are alike in what they represent -- a capital interest in the entire concerns of the corporation.

We have no doubt of the power or duty of a court to look through the form of the corporation and determine the question of the stockholder's right in order to ascertain whether he has received income taxable by Congress without apportionment. But, looking through the form, we cannot disregard the essential truth disclosed, ignore the substantial difference between corporation and stockholder, treat the entire organization as unreal, look upon stockholders as partners when they are not such, treat them as having in equity a right to a partition of the corporate assets when they have none, and indulge the fiction that they have received and realized a share of the profits of the company which in truth they have neither received nor realized.

We must treat the corporation as a substantial entity separate from the stockholder not only because such is the practical fact, but because it is only by recognizing such separateness that any dividend -- even one paid in money or property -- can be regarded as income of the stockholder. Did we regard corporation and stockholders as altogether identical, there would be no income except as the corporation acquired it, and while this would be taxable against the corporation as income under appropriate provisions of law, the individual stockholders could not be separately and additionally taxed with respect to their several shares even when divided, since, if there were entire identity between them and the company, they could not be regarded as receiving anything from it, any more than if one's money were to be removed from one pocket to another.

Conceding that the mere issue of a stock dividend makes the recipient no richer than before, the government nevertheless contends that the new certificates measure the extent to which the gains accumulated by the corporation have made him the richer. There are two insuperable difficulties with this. In the first place, it would depend upon how long he had held the stock whether the stock dividend indicated the extent to which he had been enriched by the operations of the company; unless he had held it throughout such operations, the measure would not hold true. Secondly, and more important for present purposes, enrichment through increase in value of capital investment is not income in any proper meaning of the term.

The complaint contains averments respecting the market prices of stock such as plaintiff held, based upon sales before and after the stock dividend, tending to show that the receipt of the additional shares did not substantially change the market value of her entire holdings. This tends to show that, in this instance, market quotations reflected intrinsic values -- a thing they do not always do. But we regard the market prices of the securities as an unsafe criterion in an inquiry such as the present, when the question must be not what will the thing sell for, but what is it in truth and in essence.

It is said there is no difference in principle between a simple stock dividend and a case where stockholders use money received as cash dividends to purchase additional stock contemporaneously issued by the corporation. But an actual cash dividend, with a real option to the stockholder either to keep the money for his own or to reinvest it in new shares, would be as far removed as possible from a true stock dividend, such as the one we have under consideration, where nothing of value is taken from the company's assets and transferred to the individual ownership of the several stockholders and thereby subjected to their disposal.

The government's reliance upon the supposed analogy between a dividend of the corporation's own shares and one made by distributing shares owned by it in the stock of another company calls for no comment beyond the statement that the latter distributes assets of the company among the

shareholders, while the former does not, and for no citation of authority exceptPeabody v. Eisner,247 U. S. 347, 247 U. S. 349-350.

Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of the position of the government.

Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231, arose under the Dividend Duties Act of Western Australia, which provided that "dividend" should include "every dividend, profit, advantage, or gain intended to be paid or credited to or distributed among any members or directors of any company," except, etc. There was a stock dividend, the new shares being allotted among the shareholders pro rata, and the question was whether this was a distribution of a dividend within the meaning of the act. The Judicial Committee of the Privy Council sustained the dividend duty upon the ground that, although "in ordinary language the new shares would not be called a dividend, nor would the allotment of them be a distribution of a dividend," yet, within the meaning of the act, such new shares were an "advantage" to the recipients. There being no constitutional restriction upon the action of the lawmaking body, the case presented merely a question of statutory construction, and manifestly the decision is not a precedent for the guidance of this Court when acting under a duty to test an act of Congress by the limitations of a written Constitution having superior force.

In Tax Commissioner v. Putnam, (1917) 227 Mass. 522, it was held that the Forty-Fourth amendment to the Constitution of Massachusetts, which conferred upon the legislature full power to tax incomes, "must be interpreted as including every item which by any reasonable understanding can fairly be regarded as income" (pp. 526, 531), and that under it, a stock dividend was taxable as income, the court saying (p. 535):

"In essence, the thing which has been done is to distribute a symbol representing an accumulation of profits, which, instead of being paid out in cash, is invested in the business, thus augmenting its durable assets. In this aspect of the case, the substance of the transaction is no different from what it would be if a cash dividend had been declared with the privilege of subscription to an equivalent amount of new shares. "

We cannot accept this reasoning. Evidently, in order to give a sufficiently broad sweep to the new taxing provision, it was deemed necessary to take the symbol for the substance, accumulation for distribution, capital accretion for its opposite, while a case where money is paid into the hand of the stockholder with an option to buy new shares with it, followed by acceptance of the option, was regarded as identical in substance with a case where the stockholder receives no money and has no option. The Massachusetts court was not under an obligation, like the one which binds us, of applying a constitutional amendment in the light of other constitutional provisions that stand in the way of extending it by construction.

Upon the second argument, the government, recognizing the force of the decision in Towne v. Eisner, supra, and virtually abandoning the contention that a stock dividend increases the interest of the stockholder or otherwise enriches him, insisted as an alternative that, by the true construction of the Act of 1916, the tax is imposed not upon the stock dividend, but rather upon the stockholder's share of the undivided profits previously accumulated by the corporation, the tax being levied as a matter of convenience at the time such profits become manifest through the stock dividend. If so construed, would the act be constitutional?

That Congress has power to tax shareholders upon their property interests in the stock of corporations is beyond question, and that such interests might be valued in view of the condition of the company, including its accumulated and undivided profits, is equally clear. But that this would be

taxation of property because of ownership, and hence would require apportionment under the provisions of the Constitution, is settled beyond peradventure by previous decisions of this Court.

The government relies upon Collector v. Hubbard, (1870), providing that

"The gains and profits of all companies, whether incorporated or partnership, other than the companies specified in that section, shall be included in estimating the annual gains, profits, or income of any person, entitled to the same, whether divided or otherwise."

The court held an individual taxable upon his proportion of the earnings of a corporation although not declared as dividends and although invested in assets not in their nature divisible. Conceding that the stockholder for certain purposes had no title prior to dividend declared, the court nevertheless said (p. 79 U. S. 18):

"Grant all that, still it is true that the owner of a share of stock in a corporation holds the share with all its incidents, and that among those incidents is the right to receive all future dividends -- that is, his proportional share of all profits not then divided. Profits are incident to the share to which the owner at once becomes entitled provided he remains a member of the corporation until a dividend is made. Regarded as an incident to the shares, undivided profits are property of the shareholder, and as such are the proper subject of sale, gift, or devise. Undivided profits invested in real estate, machinery, or raw material for the purpose of being manufactured are investments in which the stockholders are interested, and when such profits are actually appropriated to the payment of the debts of the corporation, they serve to increase the market value of the shares, whether held by the original subscribers or by assignees."

Insofar as this seems to uphold the right of Congress to tax without apportionment a stockholder's interest in accumulated earnings prior to dividend declared, it must be regarded as overruled by Pollock v. Farmers' Loan & Trust Co.,158 U. S. 601, 158 U. S. 627-628, 158 U. S. 637. Conceding Collector v. Hubbard was inconsistent with the doctrine of that case, because it sustained a direct tax upon property not apportioned among the states, the government nevertheless insists that the sixteenth Amendment removed this obstacle, so that now the Hubbard case is authority for the power of Congress to levy a tax on the stockholder's share in the accumulated profits of the corporation even before division by the declaration of a dividend of any kind. Manifestly this argument must be rejected, since the amendment applies to income only, and what is called the stockholder's share in the accumulated profits of the company is capital, not income. As we have pointed out, a stockholder has no individual share in accumulated profits, nor in any particular part of the assets of the corporation, prior to dividend declared.

[DOCTRINE: Thus, from every point of view, we are brought irresistibly to the conclusion that neither under the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder. The Revenue Act of 1916, insofar as it imposes a tax upon the stockholder because of such dividend, contravenes the provisions of Article I, § 2, cl. 3, and Article I, § 9, cl. 4, of the Constitution, and to this extent is invalid notwithstanding the Sixteenth Amendment.

Judgment affirmed.

REVENUE REGULATIONS NO. 02-40 INCOME TAX REGULATIONS

SECTION 49. Improvements by lessees. — When buildings are erected or improvements made by a lessee in pursuance of an agreement with the lessor, and such buildings or improvements are not subject to removal by the lessee, the lessor may at his option report the income therefrom upon either of the following bases;

(a) The lessor may report as income at the time when such buildings or improvements are completed the fair market value of such buildings or improvements subject to the lease.

(b) The lessor may spread over the life of the lease the estimated depreciated value of such buildings or improvements at the termination of the lease and report as income for each year of the lease an aliquot part thereof.

If for any other reason than a bona fide purchase from the lessee by the lessor the lease is terminated, so that the lessor comes into possession or control of the property prior to the time originally fixed for the termination of the lease, the lessor receives additional income for the year in which the lease is so terminated to the extent that the value of such buildings or improvements when he became entitled to such possession exceeds the amount already reported as income on account of the erection of such buildings or improvements.

No appreciation in value due to causes other than the premature termination of the lease shall be included.

Conversely, if the building or improvements are destroyed prior to the expiration of the lease, the lessor is entitled to deduct as a loss for the year when such destruction takes place the amount previously reported as income because of the erection of such buildings or improvements, less any salvage value subject to the lease to the extent that such loss was not compensated for by insurance. If the buildings or improvements destroyed were acquired prior to March 1, 1913, the deduction shall be based on the cost or the value subject to the lease to the extent that such loss was not compensated for by insurance.

U.S. Supreme Court

United States v. Lewis, 340 U.S. 590 (1951)

United States v. Lewis

No. 347

Argued March 2, 1951

Decided March 26, 1951

340 U.S. 590

CERTIORARI TO THE COURT OF CLAIMS

Syllabus

In his 1944 income tax return, respondent reported $22,000 received that year as an employee's bonus, which he claimed in good faith and used unconditionally as his own. In subsequent litigation, it was decided that the bonus had been computed improperly, and, under compulsion of a judgment, respondent returned $11,000 to his employer in 1946. He then sued in the Court of Claims for refund of an alleged overpayment of his 1944 income tax.

HELD: under the "claim of right" doctrine announced in North American Oil v. Burnet,286 U. S. 417, the entire $22,000 was income in 1944, and respondent was not entitled to recompute his 1944 tax.

117 Ct.Cl. 336, 91 F.Supp. 1017, reversed.

MR. JUSTICE BLACK delivered the opinion of the Court.

FACTS:

Respondent Lewis brought this action in the Court of Claims seeking a refund of an alleged overpayment of his 1944 income tax. T

he facts found by the Court of Claims are: in his 1944 income tax return, respondent reported about $22,000 which he had received that year as an employee's bonus. As a result of subsequent litigation in a state court, however, it was decided that respondent's bonus had been improperly computed; under compulsion of the state court's judgment, he returned approximately $11,000 to his employer.

Until payment of the judgment in 1946, respondent had at all times claimed and used the full $22,000 unconditionally as his own, in the good faith though "mistaken" belief that he was entitled to the whole bonus.

[IMPORTANT: On the foregoing facts, the Government's position is that respondent's 1944 tax should not be recomputed, but that respondent should have deducted the $11,000 as a loss in his 1946 tax return. See G.C.M. 16730, XV-1 Cum.Bull. 179 (1936). The Court of Claims,

however, relying on its own case, Greenwald v. United States, 102 Ct.Cl. 272, 57 F.Supp. 569, held that the excess bonus received "under a mistake of fact" was not income in 1944, and ordered a refund based on a recalculation of that year's tax. 117 Ct.Cl. 336, 91 F.Supp. 1017, 1022. We granted certiorari, 340 U.S. 903, because this holding conflicted with many decisions of the courts of appeals, see, e.g., Haberkorn v. United States, 173 F.2d 587, and with principles announced inNorth American Oil Consolidated v. Burnet,286 U. S. 417.

In the North American Oil case, we said:

[VERY IMPORTANT: "If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent."

Nothing in this language permits an exception merely because a taxpayer is "mistaken" as to the validity of his claim.]

Nor has the "claim of right" doctrine been impaired, as the Court of Claims stated, by Freuler v. Helvering,291 U. S. 35, or Commissioner v. Wilcox,327 U. S. 404. The Freuler case involved an entirely different section of the Internal Revenue Code, and its holding is inapplicable here. 291 U.S. at 291 U. S. 43. And in Commissioner v. Wilcox, supra, we held that receipts from embezzlement did not constitute income, distinguishing North American Oil on the ground that an embezzler asserts no "bona fide legal or equitable claim." 327 U.S. at 327 U. S. 408.

Income taxes must be paid on income received (or accrued) during an annual accounting period.

The "claim of right" interpretation of the tax laws has long been used to give finality to that period, and is now deeply rooted in the federal tax system.

We see no reason why the Court should depart from this well settled interpretation merely because it results in an advantage or disadvantage to a taxpayer. *

Reversed.

* It has been suggested that it would be more "equitable" to reopen respondent's 1944 tax return. While the suggestion might work to the advantage of this taxpayer, it could not be adopted as a general solution, because, in many cases, the three-year statute of limitations would preclude recovery. I.R.C. § 322(b).

MR. JUSTICE DOUGLAS, dissenting.

The question in this case is not whether the bonus had to be included in 1944 income for purposes of the tax. Plainly it should have been, because the taxpayer claimed it as of right. Some years later, however, it was judicially determined that he had no claim to the bonus. The question is whether he may then get back the tax which he paid on the money.

Many inequities are inherent in the income tax. We multiply them needlessly by nice distinctions which have no place in the practical administration of the law. If the refund were allowed, the integrity of the taxable year would not be violated. The tax would be paid when due, but the government would not be permitted to maintain the unconscionable position that it can keep the tax after it is shown that payment was made on money which was not income to the taxpayer.

Official Supreme Court case law is only found in the print version of the United States Reports. Justia case law is provided for general informational purposes only, and may not reflect current legal developments, verdicts or settlements. We make no warranties or guarantees about the accuracy, completeness, or adequacy of the information contained on this site or information linked to from this site. Please check official sources.

Republic of the Philippines SUPREME COURT

Manila

SECOND DIVISION

G.R. No. 78953 July 31, 1991

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. MELCHOR J. JAVIER, JR. and THE COURT OF TAX APPEALS, respondents.

Elison G. Natividad for accused-appellant.

SARMIENTO, J.:p

Central in this controversy is the issue as to whether or not a taxpayer who merely states as a footnote in his income tax return that a sum of money that he erroneously received and already spent is the subject of a pending litigation and there did not declare it as income is liable to pay the 50% penalty for filing a fraudulent return.

This question is the subject of the petition for review before the Court of the portion of the Decision 1 dated July 27, 1983 of the Court of Tax Appeals (CTA) in C.T.A. Case No. 3393, entitled, "Melchor J. Javier, Jr. vs. Ruben B. Ancheta, in his capacity as Commissioner of Internal Revenue," which orders the deletion of the 50% surcharge from Javier's deficiency income tax assessment on his income for 1977.

The respondent CTA in a Resolution 2 dated May 25, 1987, denied the Commissioner's Motion for Reconsideration 3 and Motion for New Trial 4 on the deletion of the 50% surcharge assessment or imposition.

The pertinent facts as are accurately stated in the petition of private respondent Javier in the CTA and incorporated in the assailed decision now under review, read as follows:

xxx xxx xxx

2. That on or about June 3, 1977, Victoria L. Javier, the wife of the petitioner (private respondent herein), received from the Prudential Bank and Trust Company in Pasay City the amount of US$999,973.70 remitted by her sister, Mrs. Dolores Ventosa, through some banks in the United States, among which is Mellon Bank, N.A.

3. That on or about June 29, 1977, Mellon Bank, N.A. filed a complaint with the Court of First Instance of Rizal (now Regional Trial Court), (docketed as Civil Case No. 26899), against the petitioner (private respondent herein), his wife and other defendants, claiming that its remittance of US$1,000,000.00 was a clerical error and should have been US$1,000.00 only, and praying that the

excess amount of US$999,000.00 be returned on the ground that the defendants are trustees of an implied trust for the benefit of Mellon Bank with the clear, immediate, and continuing duty to return the said amount from the moment it was received.

4. That on or about November 5, 1977, the City Fiscal of Pasay City filed an Information with the then Circuit Criminal Court (docketed as CCC-VII-3369-P.C.) charging the petitioner (private respondent herein) and his wife with the crime of estafa, alleging that they misappropriated, misapplied, and converted to their own personal use and benefit the amount of US$999,000.00 which they received under an implied trust for the benefit of Mellon Bank and as a result of the mistake in the remittance by the latter.

5. That on March 15, 1978, the petitioner (private respondent herein) filed his Income Tax Return for the taxable year 1977 showing a gross income of P53,053.38 and a net income of P48,053.88 and stating in the footnote of the return that "Taxpayer was recipient of some money received from abroad which he presumed to be a gift but turned out to be an error and is now subject of litigation."

6. That on or before December 15, 1980, the petitioner (private respondent herein) received a letter from the acting Commissioner of Internal Revenue dated November 14, 1980, together with income assessment notices for the years 1976 and 1977, demanding that petitioner (private respondent herein) pay on or before December 15, 1980 the amount of P1,615.96 and P9,287,297.51 as deficiency assessments for the years 1976 and 1977 respectively. . . .

7. That on December 15, 1980, the petitioner (private respondent herein) wrote the Bureau of Internal Revenue that he was paying the deficiency income assessment for the year 1976 but denying that he had any undeclared income for the year 1977 and requested that the assessment for 1977 be made to await final court decision on the case filed against him for filing an allegedly fraudulent return. . . .

8. That on November 11, 1981, the petitioner (private respondent herein) received from Acting Commissioner of Internal Revenue Romulo Villa a letter dated October 8, 1981 stating in reply to his December 15, 1980 letter-protest that "the amount of Mellon Bank's erroneous remittance which you were able to dispose, is definitely taxable." . . . 5

The Commissioner also imposed a 50% fraud penalty against Javier.

Disagreeing, Javier filed an appeal 6 before the respondent Court of Tax Appeals on December 10, 1981.

The respondent CTA, after the proper proceedings, rendered the challenged decision. We quote the concluding portion:

We note that in the deficiency income tax assessment under consideration, respondent (petitioner here) further requested petitioner (private respondent here) to pay 50% surcharge as provided for in Section 72 of the Tax Code, in addition to the deficiency income tax of P4,888,615.00 and interest due thereon. Since petitioner (private respondent) filed his income tax return for taxable year 1977, the 50% surcharge was imposed, in all probability, by respondent (petitioner) because he

considered the return filed false or fraudulent. This additional requirement, to our mind, is much less called for because petitioner (private respondent), as stated earlier, reflected in as 1977 return as footnote that "Taxpayer was recipient of some money received from abroad which he presumed to be gift but turned out to be an error and is now subject of litigation."

From this, it can hardly be said that there was actual and intentional fraud, consisting of deception willfully and deliberately done or resorted to by petitioner (private respondent) in order to induce the Government to give up some legal right, or the latter, due to a false return, was placed at a disadvantage so as to prevent its lawful agents from proper assessment of tax liabilities. (Aznar vs. Court of Tax Appeals, L-20569, August 23, 1974, 56 (sic) SCRA 519), because petitioner literally "laid his cards on the table" for respondent to examine. Error or mistake of fact or law is not fraud. (Insular Lumber vs. Collector, L-7100, April 28, 1956.). Besides, Section 29 is not too plain and simple to understand. Since the question involved in this case is of first impression in this jurisdiction, under the circumstances, the 50% surcharge imposed in the deficiency assessment should be deleted. 7

The Commissioner of Internal Revenue, not satisfied with the respondent CTA's ruling, elevated the matter to us, by the present petition, raising the main issue as to:

ISSUE:

WHETHER OR NOT PRIVATE RESPONDENT IS LIABLE FOR THE 50% FRAUD PENALTY? 8

SC RULING: NO!!

Under the then Section 72 of the Tax Code (now Section 248 of the 1988 National Internal Revenue Code), a taxpayer who files a false return is liable to pay the fraud penalty of 50% of the tax due from him or of the deficiency tax in case payment has been made on the basis of the return filed before the discovery of the falsity or fraud.

We are persuaded considerably by the private respondent's contention that there is no fraud in the filing of the return and agree fully with the Court of Tax Appeals' interpretation of Javier's notation on his income tax return filed on March 15, 1978 thus:

"Taxpayer was the recipient of some money from abroad which he presumed to be a gift but turned out to be an error and is now subject of litigation that it was an "error or mistake of fact or law" not constituting fraud, that such notation was practically an invitation for investigation and that Javier had literally "laid his cards on the table." 13

In Aznar v. Court of Tax Appeals, 14 fraud in relation to the filing of income tax return was discussed in this manner:

. . . The fraud contemplated by law is actual and not constructive. It must be intentional fraud, consisting of deception willfully and deliberately done or resorted to in order to induce another to give up some legal right. Negligence, whether slight or gross, is not equivalent to the fraud with intent to evade the tax contemplated by law. It must amount to intentional wrong-doing with the sole object of avoiding the tax. It necessarily follows that a mere mistake cannot be considered as fraudulent intent, and if both petitioner and respondent Commissioner of Internal Revenue committed mistakes in making entries in the returns and in the assessment,

respectively, under the inventory method of determining tax liability, it would be unfair to treat the mistakes of the petitioner as tainted with fraud and those of the respondent as made in good faith.

Fraud is never imputed and the courts never sustain findings of fraud upon circumstances which, at most, create only suspicion and the mere understatement of a tax is not itself proof of fraud for the purpose of tax evasion. 15

A "fraudulent return" is always an attempt to evade a tax, but a merely "false return" may not be, Rick v. U.S., App. D.C., 161 F. 2d 897, 898. 16

In the case at bar, there was no actual and intentional fraud through willful and deliberate misleading of the government agency concerned, the Bureau of Internal Revenue, headed by the herein petitioner.

The government was not induced to give up some legal right and place itself at a disadvantage so as to prevent its lawful agents from proper assessment of tax liabilities because Javier did not conceal anything.

Error or mistake of law is not fraud. The petitioner's zealousness to collect taxes from the unearned windfall to Javier is highly commendable. Unfortunately, the imposition of the fraud penalty in this case is not justified by the extant facts. Javier may be guilty of swindling charges, perhaps even for greed by spending most of the money he received, but the records lack a clear showing of fraud committed because he did not conceal the fact that he had received an amount of money although it was a "subject of litigation." As ruled by respondent Court of Tax Appeals, the 50% surcharge imposed as fraud penalty by the petitioner against the private respondent in the deficiency assessment should be deleted.

WHEREFORE, the petition is DENIED and the decision appealed from the Court of Tax Appeals is AFFIRMED. No costs.

SO ORDERED.

Melencio-Herrera, Padilla and Regalado, JJ., concur.

Paras, J., took no part.

106 F.2d 153 (1939)

HERDER et al. v. HELVERING, Com'r of Internal Revenue. HERDER v. SAME.

Nos. 7179, 7180.

United States Court of Appeals for the District of Columbia.

Decided June 26, 1939.

Writ of Certiorari Denied December 4, 1939.

*154 *155 Camden R. McAtee, of Washington, D. C., for petitioners.

James W. Morris, Asst. Atty. Gen., and Sewall Key, Norman D. Keller and W. Croft Jennings, Assts. to Atty. Gen., for respondent.

Before GRONER, Chief Justice, and MILLER and VINSON, Associate Justices.

Writ of Certiorari Denied December 4, 1939. See 60 S.Ct. 262, 84 L.Ed. ___.

VINSON, Associate Justice.

FACTS:

Two petitions for review of United States Board of Tax Appeals redeterminations of separate income tax liabilities are consolidated herein. The Board determined a deficiency against George Herder, deceased, for the period January 1 to March 29, 1934, the date of his death, (to which we will refer hereinafter as the first period) and a deficiency against his wife, Mary Herder, for the calendar year 1934.

The decedent, George Herder, and his wife Mary Herder, resided in the State of Texas and owned community property located there which produced income during the first period.

The applicable Texas statutes vest title to the community property in the husband and wife in equal parts, but, during coverture, the husband has the exclusive power of control over the property as long as he discharges his obligation as the head of the family.[1] The income from the community is divided equally between them; each may make separate returns of one-half of the income, with an equal division of the allowable deductions.[2]

The questions presented for our consideration are:

1. The disallowance of certain claimed deductions for bad debts.

2. The proper classification of proceeds from an insurance policy.

3. The proper adjusted cost basis of the property destroyed by fire.

We will consider them in the order outlined.

The Bad Debts

George Herder was in complete control of the community property. It is agreed, and so found by the Board, that, during his lifetime, he kept regular books of account for the community; that they were single entry books, kept on a cash receipts and disbursement basis; that, from time to time, bad debts were charged off by entering credits for the amounts thereof; that no reserve for bad debts was set up on the books; and, that the debts in question were never charged off on the books of account by George Herder in his life time.

The bad debts involved originally aggregated $29,975.56. In the hearing before the Board, petitioners abandoned the claim for deduction of the debt of J. W. Gates amounting to $1,861.22 as it had been charged off by George Herder in a prior taxable period. The record shows, and the Board finds, that certain other claimed bad debts, aggregating $2,521.28 became worthless in a prior taxable period and were disallowed as deductions for this reason.

We affirm the Board in this respect. Thus the bad debts we consider total $25,593.06, of which one-half, or $12,796.53, is claimed to be a deductible item to George Herder, deceased, in the first period, and an equal amount claimed to be deductible in the return of Mary Herder for the taxable year 1934. The return of the estate of George Herder, deceased, for the period March 30 to December 31, 1934, is not before us.

The George Herder Return

The Board found that the debts became worthless upon the death of George Herder because of their peculiar nature and the discontinuance of the financing of the debtors due to his death.

Sec. 23 (k) of the Revenue Act of 1934 reads, in part, as follows:

"Sec. [§] 23. Deductions from gross income. In computing net income there shall be allowed as deductions:

"* * *

"(k) Bad debts. Debts ascertained to be worthless and charged off within the taxable year * * *." 26 U.S.C.A. § 23(k).

Until his death George Herder was on a cash receipts and disbursement basis, and kept books of account. During prior years, from time to time, he charged off worthless debts by entries on the books. In such a case debts must not only be ascertained to be worthless within the taxable year, but they must be charged off within the taxable year.[3] The Board found that these essentials were not present in his case; that there was no charge off on the books, and that the debts did not become worthless within that taxable period.

Petitioners however maintain that the enactment of secs. 42 and 43 of the Revenue Act of 1934[4] eliminates the application of sec. 23 (k) herein; that it removed George Herder from his position as a taxpayer upon a cash receipts and disbursement basis, and placed him upon an

accrual basis for the taxable period involved; and, that the books of account actually kept by him are not to be considered.

In considering the contention of petitioners we must consider the legislative history of secs. 42 and 43.

From its very terms, and as is clearly expressed in the reports of the congressional committees[5] handling the legislation, it is evident that sec. 42 found its way into the tax law for the purpose of preventing ordinary income from escaping taxation.

Previously, whenever a taxpayer on a cash receipts and disbursement basis died, income accrued up to his death passed to the estate as a part of the corpus, escaping the income tax mill altogether. Sec. 42, enacted to cover the situation, "includes" in taxable income "for the taxable period in which falls the date of his [taxpayer's] death, amounts accrued up to the date of his death". Thus the taxable income for such period is the income of the taxpayer actually received, plus the income accrued but not received. The objective of Congress, which must always be kept in mind, is that the net income of the taxpayer, prior to his death, bear the burden of income taxes, regardless of his tax basis, or whether he kept books, and that the income accrued should be added to the income actually received.

On the other hand it is evident that in subjecting such additional income to taxation, Congress intended to permit additional deductions to such taxpayers. Sec. 43 makes allowable "deductions * * * for the taxable period in which falls the date of his [taxpayer's] death, amounts accrued up to the date of his death * * *." This could only mean such deductions that were not allowable to a taxpayer on a cash basis prior to the enactment of sec. 43.

The purpose of Congress was to see reflected in the return of such decedent credits and deductions which had accrued, whether reflected on the books of the taxpayer or not. It required sec. 43 to remove what would be an otherwise unjust burden resulting from sec. 42. There is nothing contained in secs. 42 and 43 indicating that the provisions in sec. 23 (k) relating to the ascertainment of a debt to be worthless within the taxable year and its charge-off are dispensed with. These two requirements are embedded in the tax laws and are necessary to be met before bad debts become deductible items.

In this view, we cannot agree with petitioners that sec. 23 (k) should be eliminated in the computation of the George Herder return, and we cannot follow them in their desire for such elimination, since it is solely through sec. 23 (k) that bad debts are allowed to be deducted from gross income; nor can we conclude that secs. 42 and 43 abolish the books kept by the taxpayer.

However, we can agree that the tax basis of George Herder was modified as a result of his death. In his lifetime he was upon a cash receipts and disbursement basis, keeping books of account. In this position he had until the last day of the taxable year in which to determine the worthlessness of the debts and to charge them off. He died within the taxable year without having done either. Secs. 42 and 43 changed his basis. The change was not of his choosing. He died and the law changed it for him. Sec. 23 (k) applies to a taxpayer regardless of his basis. The debts must become worthless within the taxable year. The worthlessness of the debt is a fact to be determined — not the opinion of the taxpayer.[6] This essential was met by the personal representatives of George Herder. The correctness of their conclusion as to their worthlessness within the taxable year is here admitted. The Board so found. Thus sec. 23 (k) in this respect has been complied with.

We come to the charge-off. George Herder did not charge these debts off the books which he kept. He could not do so because they were not worthless to him. If the debts had actually become worthless during the first period, his failure to charge them off on the books would not, in our opinion, have precluded their deduction from gross income. In such a situation, they would have become an accrued deduction which sec. 43 permits to be reflected in the taxable income, and the charge-off within his taxable period, required by sec. 23 (k) would be made by operation of law. But the debts involved in the present case were not worthless within the taxable period. It is admitted, and found by the Board that they became worthless only upon the death of George Herder. Consequently, they cannot be accrued as a deduction under sec. 43 and, in our opinion, may not be deducted in the George Herder return. We therefore affirm the Board's determination in this respect.

The Mary Herder Return

Mary Herder made her tax return for the full calendar year 1934. What we have said in respect of the worthless debts in connection with the return of George Herder for the first period equally controls Mary Herder for the same period. *158 The books for the community were kept by George Herder, and throughout the years debts were ascertained to be worthless and charged off.

George Herder fixed the basis of the community while it existed and, as there is nothing in the record indicating that Mary Herder had income other than that received from the community, her basis for the period prior to his death, was determined by the basis fixed for the community.

However, upon the death of George Herder the community terminated and Mary Herder became a new taxpaying personality, with the right to elect upon what basis she would make her returns, as well as to determine whether or not she would keep books. In her new status deductibility of the debts involved depends upon whether she kept books.

The Board found that after George Herder's death his books were kept by R. L. Williams "for the executors of the estate of the decedent and for Mary Herder"; that "no other books of account were kept by or for the decedent, the executors of his estate, or Mary Herder".

Whenever there is substantial evidence to support a finding of the Board upon a question of fact, its decision of that question is conclusive upon review.[7] In our opinion, there is no evidence in the record before us that Mary Herder kept any books of account for this or any period, nor can we find any evidence supporting the finding that any books were kept for her. R. L. Williams married a daughter of George and Mary Herder. He was also the owner of a one-third interest with George Herder in the partnership operating a rice mill. He managed the rice mill and in this connection kept books for the partnership. He did not keep books for George Herder, or for the community while it existed. Because of its pertinence, we set out in the margin his testimony relating to his bookkeeping.[8]

The accountant, Moore, testified that he "prepared his [George Herder's] income returns until his death" and "prepared the income tax returns after his death for him, for his estate, and those of Mrs. Herder for several prior years."

We cannot conclude that this evidence supports the Board's findings that Mary Herder kept books, or that Williams, authorized or unauthorized, kept books for Mary Herder.

The record does not disclose who prepared the return for 1934, but, assuming that Mary Herder's return was based upon information disclosed in the books kept by Williams, there still is no evidence in the record that she, who had *159 a right of election in respect thereto, kept books of account upon which her personal return was based. Appeal of Brander, 3 B.T.A. 231, 235.

It follows that, if she kept no books of account, or if none were authorized to be kept for her, there was no way in which she could show an actual charge off of the bad debts upon books, nor was there any responsibility under the statute for her so doing.

All required of her would be to claim their deduction upon her tax return for the period in which the debts became worthless, which she did. There is no contention by the Commissioner that such debts may not be deducted in the tax return for the period in which they are so ascertained to be worthless. They are so deductible.[9] Therefore, we are of the opinion that one-half of the amount of the debts involved, to-wit, $12,796.53 is properly deductible by Mary Herder in her return for the taxable year 1934.

The Proceeds of the Insurance Policy

On January 15, 1934, prior to the death of George Herder, fire destroyed the milling property owned by the partnership. For this loss, the partnership received, in settlement of insurance claims under policies carried by it, $50,000. Such amount was immediately distributed to the partners, being pro-rated in accordance with their respective interest in the partnership, namely, two-thirds to George Herder, and one-third to R. L. Williams.

The Board found that George Herder received $33,333.67 under such distribution and that $19,199.50 thereof represented his portion of the total amount received by the partnership in excess of the adjusted cost basis of the property (original cost, plus improvements, less accrued depreciation) at the time of its destruction, (hereinafter referred to as proceeds) and that such proceeds were taxable as ordinary income to the community.[10]

The personal representatives of George Herder, deceased, maintain (a) that it is not income taxable to the community, but that it is income taxable to the estate of George Herder; and, further (in which Mary Herder as an individual joins) that (b) the proceeds received is not ordinary income, but is a capital gain from the sale or exchange of a capital asset and should be taxed as such.

(a) In contending that the proceeds received was not taxable in the first period, the personal representatives rely upon sec. 112 (f).[11] They urge that the record shows, and the Board finds, that George Herder had definite intentions, from the time he received such proceeds until his death, to reinvest the whole amount thereof in similar property, thereby coming within the provisions of sec. 112 (f), in which event no gain or loss would occur in such taxable period. They urge that the Board's determination as to the disposition of the proceeds received by R. L. Williams, a member of the partnership, bears them out in this contention.

The Board found that Williams had similar intentions of reinvesting his portion of the proceeds in similar property; that he made bona fide efforts so to reinvest, but did not actually reinvest such proceeds until a date 14 months subsequent *160 to receiving it. The Commissioner had refused Williams the application of sec. 112 (f) to such funds; the Board found that the section should apply, His return is not before us.

A very persuasive argument is presented that inasmuch as the Board permitted the benefits of sec. 112 (f) to extend to Williams, they should likewise apply the same treatment to George Herder, deceased, who had like intentions of reinvestment, but was prevented from actually doing so because of his death. The only authority cited in this connection is Buckhardt v. Commissioner, 32 B.T.A. 1272, in which actual reinvestment was made.

If, as we view it, the proceeds is income to the taxpayer prior to his death, it is taxable in the period when it is received, and can only be relieved from taxation by compliance with sec. 112 (f), that is by actual reinvestment in similar property as required thereunder.

The Board's action in applying sec. 112 (f) and its benefits to Williams in the present case and to Buckhardt in the case cited above cannot have any effect on the taxability of George Herder's income in the absence of any reinvestment at all. Sec. 112 (f) is a liberal provision which may remove such income from a taxable status within the period when it was received. It is based upon the theory that taxation is deferred until a subsequent date, but only upon condition that there is a reinvestment of such income in similar property, which takes the basis for gain or loss of the property involuntarily converted.

We are of the opinion that the proceeds of the insurance was taxable income received in the prior period, and, not having been reinvested, sec. 112 (f) cannot be availed of to avoid payment of taxes in the period the income was received. Upon the death of George Herder, the proceeds constituted a portion of his estate and could not be taxed as income derived by the estate.

[VERY IMPORTANT!!! ON INVOLUNTARY CONVERSION: The mill was insured and it burned down. Thus, the mill was “converted” into cash in the form of insurance proceeds. However, the SC held that the proceeds of the fire insurance policy did not result from either a sale or exchange of property and thus CANNOT be subject of CAPITAL GAINS TAX. Therefore, the Board properly treated the proceeds from it as ORDINARY INCOME and not as capital gain.]

(b) Petitioners very strongly urge that the taxable income growing out of the involuntary conversion of the mill, should not be, in any event, treated as ordinary income, but should be treated as a capital gain and subjected to taxation under sec. 117.[12]

They contend that the definition of "sale or exchange" of the capital gain and loss section of the statute is widened by sec. 117 (f),[13] and that under its provisions liquidated insurance proceeds come within its terms. They argue that "the payment of $50,000 herein is only incidentally according to the terms of insurance policies, and is in fact a payment of a liquidated claim arising upon occurrence of the total loss by fire." Thus it is their theory that the present case "is to be decided in its actual aspect as involving a `sale or exchange' giving rise to a capital gain."

[VERY IMPORTANT: It is obvious that the proceeds of the fire insurance policy did not result from either a sale or exchange of property.[14]

This payment is the satisfaction of a contract of insurance indemnifying against contingent loss by fire.[15]

It is true that in the Revenue Act of 1934 new language found its way into the law under sec. 117 (f) broadening the scope of the capital gain and loss section, but this language, as we read it, is not helpful to the petitioners in the present situation.

[VERY IMPORTANT: It seems to us to be clear that sec. 117 (f) CANNOT refer to a fire insurance policy, even when a liquidated demand is paid under it.

The petitioners would construe the terms of the *161 statute "other evidences of indebtedness issued by any corporation * * * with interest coupons or in registered form" to include a fire insurance policy for the reason that in case of total loss the policy by statute "shall be held and considered to be a liquidated demand against the company for the full amount of such policy

Taking this section, 117 (f), in its entirety, as we must, we are unable to agree with them. The fire insurance policy, in our opinion, is not an evidence of indebtedness contemplated by this section. It would seem to us, from its position in the text, that "other evidences of indebtedness" refers to something more closely akin to bonds, debentures, notes and certificates. Were the language of this section ambiguous, the report of the committee handling the legislation may be used in a search for "the voice of Congress."[16]

SC RULING:

As the insurance policy does not come within the purview of sec. 117, or subdivision (f) thereof, the Board properly treated the proceeds from it as ordinary income and not as capital gain.

Adjusted Cost Basis

Further the petitioners maintain that whether the proceeds are taxable as ordinary income to the community or should be treated under the capital gain section, the Commissioner and the Board have erred in their method of computation in determining the adjusted cost basis of the property. They make three contentions in their effort to show error:

1. That certain expenditures treated as ordinary expenses should be considered as capital expenditures.

2. That failing to take amounts allowable as deductions for depreciation on their returns for prior years, these expenditures should be permitted to off-set depreciation, and no depreciation should be considered in computing the adjusted cost basis.

3. And, further, that the marketable value should be used in a computation of the adjusted cost basis, rather than the original cost of the property, plus additions.

It is well settled that the burden of proof is on the taxpayer to show that the commissioner's determination is invalid.[17] This rule has often been applied in controversies over the proper cost basis in the computation of gains from sales and exchanges of property.[18] In this instance, the taxpayer has not pointed out the specific items improperly charged to expenses, and in our opinion, has failed to support this burden.[19] However, notwithstanding the petitioners failure in this respect, we have made a careful analysis of the method used in the determination of the adjusted cost basis to the taxpayer of the property involved, and find that proper credits have been allowed for all capital expenditures during such period; that the amounts expended for repairs, maintenance and similar items, now sought to be capitalized by the petitioners, were properly considered as ordinary expenses, and deducted as such in their prior annual returns.

2. The adjusted cost basis is defined by the statute to be:

"Sec. [§] 113. Adjusted basis for determining gain or loss.

* * * * * *

"(b) Adjusted basis. The adjusted basis for determining the gain or loss from the sale or other disposition of property, whenever acquired, shall be the basis determined under subsection (a), adjusted as hereinafter provided.

"(1) General Rule. Proper adjustment in respect of the property shall in all cases be made —

* * * * * *

"(B) * * * for exhaustion, wear and tear * * * to the extent allowed (but not less than the amount allowable) *162 under this Act or prior income-tax laws. * * *" (Italics supplied) 26 U.S.C.A. § 113(b).

Subsection (a) referred to in the above provides "The basis of property shall be thecost of such property," with exceptions not material. (Italics supplied)

In determining the adjusted cost basis of property sold, exchanged or otherwise disposed of it is immaterial whether petitioners availed themselves of allowable deductions for depreciation in their prior tax returns. Failing to take depreciation when it occurs in the prior taxable years does not prevent its inclusion in the determination of the adjusted cost basis of the property.[20]

3. The petitioners point out that the marketable value of the property at the time of its destruction was $75,000 and that it is from this sum that the depreciation, if any, should be deducted. Again we turn to the statute. It is not the marketable value of this property that enters into the computation, it is the original cost, plus additions that must be used. Sec. 113 (b), supra. Such original cost, plus additions to capital, less depreciation results in the statutory term — the adjusted cost basis.

In this case the amount received under the fire insurance policy was $50,000. The adjusted cost basis, taking into consideration the amount received by the partnership for the salvage was properly found by the Board to be $21,200.74. The difference between these two sums, to wit, $28,799.26 reflects the taxable realization on the transaction. We affirm the Board in this respect.

No. 7179 — affirmed.

No. 7180 — affirmed in part and reversed in part, and remanded to the United States Board of Tax Appeals for proceedings in accordance with the opinion.