The Income Tax Act of October 3, 1913, c. 16, 38 Stat. 166, drew
a distinction between a shareholder's undivided interest in the
gains and profits of a corporation prior to declaration of a
dividend and his participation in the dividends declared and paid,
treating the latter, in ordinary circumstances, as part of his
income for the purpose of the "surtax" and not regarding the former
as taxable to him unless fraudulently accumulated to evade the
tax.
Under the Sixteenth Amendment, Congress may tax without
apportionment dividends received in the ordinary course by a
shareholder from a corporation, even though extraordinary in amount
and derived from a surplus of corporate assets existing before the
Amendment.
Under the Income Tax Act of 1913, dividends declared and paid in
the ordinary course by a corporation to its shareholders after
March 1, 1913, whether from current earnings or from a surplus
accumulated before that date, were taxable to the individual
shareholder as income under the "surtax" provision.
Lynch v.
Turrish, ante, 247 U. S. 221, and
Southern Pacific Co. v. Lowe, ante, 247 U. S. 330,
distinguished.
236 F. 661 reversed.
The case is stated in the opinion.
Page 247 U. S. 340
MR. JUSTICE PITNEY delivered the opinion of the Court.
Hornby, the respondent, recovered a judgment in the United
States district court against Lynch, as Collector of Internal
Revenue, for the return of $171 assessed as an additional income
tax under the Act of October 3, 1913, c. 16, 38 Stat. 114, 166, and
paid under protest. The circuit court of appeals affirmed the
judgment, 236 F. 661, and the case comes here on certiorari. It was
submitted at the same time with
Lynch v. Turrish, ante,
247 U. S. 221,
Southern Pacific Co. v. Lowe, ante, 247 U. S. 330, and
Peabody v. Eisner, ante, 247 U. S. 347,
arising under the same act and this day decided.
The facts in brief are as follows: Hornby, from 1906 to 1915,
was the owner of 434 (out of 10,000) shares of the capital stock of
the Cloquet Lumber Company, an Iowa corporation, which for more
than a quarter of a century had been engaged in purchasing timber
lands, manufacturing the timber into lumber, and selling it. Its
shares had a par value of $100 each, making the entire capital
stock $1,000,000. On and prior to March 1, 1913, by the increase of
the value of its timber lands and through its business operations,
the total property of the company had come to be worth $4,000,000,
and Hornby's stock, the par value of which was $43,400, had
become
Page 247 U. S. 341
worth at least $150,000. In the year 1914, the company was
engaged in cutting its standing timber, manufacturing it into
lumber, selling the lumber, and distributing the proceeds among its
stockholders. In that year, it thus distributed dividends
aggregating $650,000, of which $240,000, or 24 percent of the par
value of the capital stock, was derived from current earnings, and
$410,000 from conversion into money of property that it owned or in
which it had an interest on March 1, 1913. Hornby's share of the
latter amount was $17,794, and this not having been included in his
income tax return, the Commissioner of Internal Revenue levied an
additional tax of $171 on account of it, and this forms the subject
of the present suit.
The case was tried in the district court and argued in the
circuit court of appeals together with
Lynch v. Turrish,
236 F. 653, and was treated as presenting substantially the same
question upon the merits. In our opinion, it is distinguishable
from the
Turrish case, where the distribution in question
was a single and final dividend received by Turrish from the
Payette Company in liquidation of the entire assets and business of
the company and a return to him of the value of his stock upon the
surrender of his entire interest in the company at a price that
represented its intrinsic value at and before March 1, 1913, when
the Income Tax Act took effect.
In the present case, there was no winding up or liquidation of
the Cloquet Lumber Company, nor any surrender of Hornby's stock. He
was but one of many stockholders, and had but the ordinary
stockholder's interest in the capital and surplus of the company --
that is, a right to have them devoted to the proper business of the
corporation and to receive from the current earnings or accumulated
surplus such dividends as the directors in their discretion might
declare.
Gibbons v. Mahon, 136 U.
S. 549,
136 U. S. 557.
The operations of this company in the year 1914
Page 247 U. S. 342
were, according to the facts pleaded, of a nature essentially
like those in which it had been engaged for more than a quarter of
a century. The fact that they resulted in converting into money,
and thus setting free for distribution as dividends, a part of its
surplus assets accumulated prior to March 1, 1913, does not render
Hornby's share of those dividends any the less a part of his income
within the true intent and meaning of the act, the pertinent
language of which is as follows (38 Stat. 166, 167):
"A. Subdivision 1. That there shall be levied, assessed,
collected and paid annually upon the entire net income arising or
accruing from all sources in the preceding calendar year to every
citizen of the United States, . . . and to every person residing in
the United States, . . . a tax of 1 percentum per annum upon such
income, except as hereinafter provided. . . ."
"B. That, subject only to such exemptions and deductions as are
hereinafter allowed, the net income of a taxable person shall
include gains, profits, and income derived from salaries, wages, or
compensation for personal service, . . . also from interest, rent,
dividends, securities, or the transaction of any lawful business
carried on for gain or profit, or gains or profits and income
derived from any source whatever."
Among the deductions allowed for the purpose of the normal tax
is
"seventh, the amount received as dividends upon the stock or
from the net earnings of any corporation, . . . which is taxable
upon its net income as hereinafter provided."
There is a graduated additional tax, commonly known as a
"surtax," upon net income in excess of $20,000, including income
from dividends, and for the purpose of this additional tax,
"the taxable income of any individual shall embrace the share to
which he would be entitled of the gains and profits, if divided or
distributed, whether divided or distributed or not, of all
corporations . . . formed or fraudulently
Page 247 U. S. 343
availed of for the purpose of preventing the imposition of such
tax through the medium of permitting such gains and profits to
accumulate instead of being divided or distributed."
It is evident that Congress intended to draw and did draw a
distinction between a stockholder's undivided share or interest in
the gains and profits of a corporation, prior to the declaration of
a dividend, and his participation in the dividends declared and
paid; treating the latter, in ordinary circumstances, as a part of
his income for the purposes of the surtax, and not regarding the
former as taxable income unless fraudulently accumulated for the
purpose of evading the tax.
This treatment of undivided profits applies only to profits
permitted to accumulate after the taking effect of the act, since
only with respect to these is a fraudulent purpose of evading the
tax predicable. Corporate profits that accumulated before the act
took effect stand on a different footing. As to these, however,
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.
The act took effect on March 1, 1913, a few days after the
requisite number of states had given approval to the Sixteenth
Amendment, under which, for the first time, Congress was empowered
to tax income from property without apportioning the tax among the
states according to population.
Southern Pacific Co. v. Lowe,
supra. That the retroactivity of the act from the date of its
passage (October 3, 1913) to date not prior to the adoption of the
amendment was permissible is settled by
Brushaber v. Union
Pacific R. Co., 240 U. S. 1. And we
deem it equally clear that Congress
Page 247 U. S. 344
was at liberty under the amendment to tax as income, without
apportionment, everything that became income, in the ordinary sense
of the word, after the adoption of the amendment, including
dividends received in the ordinary course by a stockholder from a
corporation, even though they were extraordinary in amount and
might appear upon analysis to be a mere realization in possession
of an inchoate and contingent interest that the stockholder had in
a surplus of corporate assets previously existing. Dividends are
the appropriate fruit of stock ownership, are commonly reckoned as
income, and are expended as such by the stockholder without regard
to whether they are declared from the most recent earnings, or from
a surplus accumulated from the earnings of the past, or are based
upon the increased value of the property of the corporation. The
stockholder is, in the ordinary case, a different entity from the
corporation, and Congress was at liberty to treat the dividends as
coming to him
ab extra, and as constituting a part of his
income when they came to hand.
Hence, we construe the provision of the act that
"the net income of a taxable person shall include gains,
profits, and income derived from . . . interest, rent, dividends, .
. . or gains or profits and income derived from any source
whatever"
as including (for the purposes of the additional tax) all
dividends declared and paid in the ordinary course of business by a
corporation to its stockholders after the taking effect of the act
(March 1, 1913), whether from current earnings or from the
accumulated surplus made up of past earnings or increase in value
of corporate assets, notwithstanding it accrued to the corporation
in whole or in part prior to March 1, 1913. In short, the word
"dividends" was employed in the act as descriptive of one kind of
gain to the individual stockholder, dividends being treated as the
tangible and recurrent returns upon his stock, analogous to the
interest
Page 247 U. S. 345
and rent received upon other forms of invested capital.
In the more recent Income Tax Acts, provisions have been
inserted for the purpose of excluding from the effect of the tax
any dividends declared out of earnings or profits that accrued
prior to March 1, 1913. This originated with the Act of September
8, 1916, and has been continued in the Act of October 3, 1917.
* We are referred
to the legislative history of the Act of 1916, which it is
contended indicates that the new definition of the term "dividends"
was intended to be declaratory of the meaning
Page 247 U. S. 346
of the term as used in the 1913 Act. We cannot accept this
suggestion, deeming it more reasonable to regard the change as a
concession to the equity of stockholders granted in the 1916 act,
in view of constitutional questions that had been raised in this
case, in the companion case of
Lynch, v. Turrish, and
perhaps in other cases. These two cases were commenced in October,
1915, and decisions adverse to the tax were rendered in the
district court in January, 1916, and in the circuit court of
appeals September 4, 1916.
We repeat that, under the 1913 Act, dividends declared and paid
in the ordinary course by a corporation to its stockholders after
March 1, 1913, whether from current earnings or from a surplus
accumulated prior to that date, were taxable as income to the
stockholder.
We do not overlook the fact that every dividend distribution
diminishes by just so much the assets of the corporation, and in a
theoretical sense reduces the intrinsic value of the stock. But, at
the same time, it demonstrates the capacity of the corporation to
pay dividends, holds out a promise of further dividends in the
future, and quite probably increases the market value of the
shares. In our opinion, Congress laid hold of dividends paid in the
ordinary course as
de facto income of the stockholder,
without regard to the ultimate effect upon the corporation
resulting from their payment.
Of course, we are dealing here with the ordinary stockholder
receiving dividends declared in the ordinary way of business.
Lynch v. Turrish and
Southern Pacific Co. v. Lowe
rest upon their special facts, and are plainly distinguishable.
It results from what we have said that it was erroneous to award
a return of the tax collected from the respondent, and that the
judgment should be
Reversed, and the cause remanded to the district court for
further proceedings in conformity with this opinion.
* In Act Sept. 8, 1916, c. 463, 39 Stat. 756, 757, which took
the place of the Act of 1913, the substance of what we have quoted
from paragraph B of the 1913 Act, was embodied in § 2(a), but with
this proviso:
"
Provided, that the term 'dividends' as used in this
title shall be held to mean any distribution made or ordered to be
made by a corporation . . .
out of its earnings or profits
accrued since March first, nineteen hundred and thirteen, and
payable to its shareholders, whether, in cash or in stock of the
corporation,"
etc. And, by Act Oct. 3, 1917, c. 63, 40 Stat. 300, 329, 337,
338, § 2(a) of the 1916 Act was amended by being repeated without
the proviso (p. 329), while the proviso was inserted as a new
§section -- 31(a) -- and to it was added a subsection, (b), as
follows:
"(b) Any distribution made to the shareholders or members of a
corporation . . . in the year nineteen hundred and seventeen, or
subsequent tax years, shall be deemed to have been made from the
most recently accumulated undivided profits or surplus, and shall
constitute a part of the annual income of the distributee for the
year in which received, and shall be taxed to the distributee at
the rates prescribed by law for the years in which such profits or
surplus were accumulated by the corporation, . . . but
nothing
herein shall be construed as taxing any earnings or profits accrued
prior to March first, nineteen hundred and thirteen, but such
earnings or profits may be distributed in stock dividends or
otherwise, exempt from the tax, after the distribution of earnings
and profits accrued since March first, nineteen hundred and
thirteen, has been made. This subdivision shall not apply to any
distribution made prior to August sixth, nineteen hundred and
seventeen, out of earnings or profits accrued prior to March first,
nineteen hundred and thirteen."