Article 115-3 of Treasury Regulations 101, promulgated under the
Revenue Act of 1938, requires that, for computing under §
112(b)(7)(E) the amount of "earnings and profits" distributed by a
corporation as liquidating dividends with respect to securities
which the corporation had acquired by tax-free exchanges for its
own stock and had later sold, the basis be the transferor's cost,
rather than the value of the securities at the time of their
acquisition by the corporation.
Held:
1. The regulation was reasonable, and a valid exercise of the
rulemaking power. P.
324 U. S.
546.
2. Though the Tax Court relied on § 501 of the Second Revenue
Act of 1940, it is unnecessary here to determine the
constitutionality of applying that section retroactively. P.
324 U. S.
547.
143 F.2d 162 reversed.
Certiorari, 323 U.S. 694, to review the reversal of a decision
of the Tax Court, 1 T.C. 640, which sustained the Commissioner's
determination of deficiencies in income tax.
Page 324 U. S. 543
MR. JUSTICE JACKSON delivered the opinion of the Court.
The Circuit Court of Appeals for the Ninth Circuit has held
Section 501(a) of the Second Revenue Act of 1940 to be
unconstitutional. [
Footnote 1]
This, of course, called for grant of certiorari. [
Footnote 2]
Since our problem is not computation of a tax, the facts
relevant to the issues in the five cases, consolidated on appeal
may be shortly stated. In 1925, John H. Wheeler and his wife,
Frances, organized under the laws of California the John H. Wheeler
Company. Then and thereafter, they transferred an assortment of
securities to it in exchange for shares of its common stock. The
securities had cost them $304,683.49, and, at transfer, had a fair
market value of $491,800. In exchange, the Wheelers received 4,918
shares with a par value of $100 each. No gain by them was
recognized for income tax purposes by reason of the exchange.
Cf. Internal Revenue Code, § 112(b)(5).
For purposes of determining its income tax liability on
subsequent disposition of the securities, the corporation was
obliged to and did use as a cost base the cost of the securities to
the transferors, $304,684.49.
Cf. Internal Revenue Code, §
113(a)(8). But, for its corporate accounting, the corporation set
up a cost of $491,800, market value at the
Page 324 U. S. 544
time of acquisition in exchange for common stock of equal par
value. The whole question in this case is which of these bases is
to be used to compute, pursuant to § 112(b)(7)(E) of the Revenue
Act of 1938, 52 Stat. 447, 488, the amount of "earnings and
profits" distributed as liquidating dividends. The Act in 1938, to
induce corporate liquidations, permitted a qualified stockholder to
elect postponement of a portion of the gain realized on a December,
1938, liquidation, and to be taxed, as for a dividend, on "so much
of the gain as is not in excess of his ratable share of the
earnings and profits of the corporation. . . ." If the market value
basis is used for the securities acquired from the Wheelers and
later sold, the operations of the Company showed a deficit on
November 30, 1938, when the books were closed. If the "cost to
transferors" basis is used, "earnings and profits" were distributed
to respondents, the stockholders, in the amount of $132,813.48, as
computed by the Commissioner. [
Footnote 3]
After considering the applicability of § 112(b)(7), the
stockholders duly dissolved the corporation and distributed its
assets during December, 1938. They elected to be taxed on the gains
on their shares pursuant to § 112(b)(7), and they reported, of
course, according to the higher or market value basis for the
securities acquired and disposed of by the Company. The
Commissioner asserted a deficiency based on the lower cost to the
transferors. In explaining his determination, he relied on § 501(a)
of the Second Revenue Act of 1940, 54 Stat. 974, 1004, which
provides that earnings and profits on the sale or other disposition
of property shall be determined by using the adjusted basis for
determining gains and by recognizing such gains to the extent that
they are recognized for computing net income, and on § 501(c),
which makes the provisions of § 501(a) applicable to prior
years.
Page 324 U. S. 545
The Tax Court sustained the Commissioner. [
Footnote 4] It held § 501(a) of the Act of 1940 a
"complete answer" to taxpayers' contention, and it overruled their
claim that, if the section was applicable to increase their 1938
liability, it was retroactive in contravention of the Fifth
Amendment to the Constitution. The Circuit Court of Appeals agreed
that the section was applicable, but held that such retroactivity
rendered it unconstitutional.
Although the term "earnings and profits" has long been in the
revenue acts in connection with the definition of dividends, it has
never been defined by the statutes [
Footnote 5] (except insofar as § 501(a) of the Second Act
of 1940 has now done so). But, under the Revenue Act of 1934 and
succeeding acts, the Commissioner dealt by regulation with that
portion of the problem of definition relevant here. Article 115-3
of Treasury Regulations 101, promulgated under the 1938 Act,
provided in part as follows;
"Gains and losses within the purview of Section 112 or
corresponding provision of prior Acts are brought into the earnings
and profits at the time and to the extent such gains and losses are
recognized under that section. [
Footnote 6]"
This regulation, if valid, disposes of the controversy, for,
when the corporation sold its securities acquired from the
Wheelers, it realized gain, based on transferor's cost, which was
fully recognized under § 112.
The only reason to doubt the validity of the regulation is found
in certain decisions of the Board of Tax Appeals and lower courts
mentioned in the Tax Court's opinion. Despite these adverse
decisions, however, the Commissioner
Page 324 U. S. 546
persisted in applying the regulation. The question was never
reviewed here. Before it was finally judicially considered,
Congress enacted § 501 of the Second Revenue Act of 1940, as the
committee reports show, [
Footnote
7] to "clarify the law" by enacting the substance of the
regulation. But, if the regulation itself was valid and effective,
the clarifying amendment of 1940 added nothing to the liability of
these taxpayers, and even though the Tax Court relied on it, rather
than on the regulation, no question of retroactivity is
presented.
We think the regulation is reasonable, and a valid exercise of
the rulemaking power. The taxpayers are insisting on using as a
base for tax purposes a figure that, in itself, had no relation to
taxation. It was no doubt permissible, and perhaps the correct
accounting for determining earned surplus for dividends and such
corporate purposes, for the corporation to set up its books on the
market value of its property at the time of acquisition, which
determined the value of the stock it issued. But "earnings and
profits" in the tax sense, although it does not correspond exactly
to taxable income, does not necessarily follow corporate accounting
concepts, either. [
Footnote 8]
Congress has determined that, in certain types of transaction, the
economic changes are not definitive enough to be given tax
consequences, and has clearly provided that gains and losses on
such transactions shall not be recognized for income tax liability,
but shall be taken account of later. §§ 112, 113. It is sensible to
carry through the theory in determining the tax effect of such
transactions on earnings and profits.
Compare Commissioner v.
Sansome, 60 F.2d 931,
and see Sen.Rep. No. 2156, 74th
Cong., 2d Sess., p. 19; H.R.Rep. No. 2894, 76th Cong., 3d Sess., p.
41. Indeed, Congress appears to have provided for this result in
the statute
Page 324 U. S. 547
itself, § 111(c) of the 1938 Act, which declares:
"In the case of a sale or exchange, the extent to which the gain
or loss determined under this section shall be recognized
for
the purposes of this title shall be determined under the
provisions of section 112. [
Footnote 9]"
In this case, to be sure, there was no question of recognition
of gain or loss to the corporation at the time of the exchange with
the Wheelers, because it was issuing its own stock, and so realized
no gain or loss. But to recognize the increment in value as
affecting earnings and profits would no more harmonize with the
taxless character of the transaction than to treat a realized gain
as doing so. The same policy which carries over the transferor's
basis for purposes of the corporation's income tax, § 113(a)(8),
requires carrying it over for determining the taxability of its
distributions as the Commissioner's regulation directs: gains and
losses are to be brought into earnings and profits at the time and
"to the extent" that they are recognized under § 112. Finally, no
doubt of the reasonableness of the rule can linger in the presence
of § 501(a), by which Congress has indicated its express approval
of the principle that the basis for determining earnings and
profits shall be the basis for determining gain.
We therefore think that, on principles often reiterated,
[
Footnote 10] the regulation
is valid and decisive of this issue. There is no necessity to
predicate the determination of deficiency on the 1940 amendment.
The 1940 amendment consequently
Page 324 U. S. 548
has no retroactive effect on the liability of these taxpayers,
and the conclusion of the Court of Appeals that it is
unconstitutional is not warranted. The judgment of the Court of
Appeals is reversed. and that of the Tax Court is affirmed.
Reversed.
MR. JUSTICE ROBERTS is of opinion the judgment should be
affirmed for the reasons stated by the Circuit Court of Appeals,
143 F.2d 162.
[
Footnote 1]
143 F.2d 162.
[
Footnote 2]
323 U.S. 694.
[
Footnote 3]
This was slightly modified by the Tax Court in an aspect not
material here.
[
Footnote 4]
1 T.C. 640.
[
Footnote 5]
See Paul, Selected Studies in Federal Taxation, Second
Series, 1938, 149, 155
et seq.
[
Footnote 6]
The provision appears in Reg. 94, Art. 115-3, under the Act of
1936; Reg. 86, Art. 115-1, under the Act of 1934, and in Reg. 103,
Sec.19.115-3, and Reg. 111, Sec. 29.115-3, under the Internal
Revenue Code.
[
Footnote 7]
See H.R. Rep. No. 2894, 76th Cong., 3d Sess., p. 41;
Sen.Rep. No. 2114, 76th Cong., 3d Sess., p. 22.
[
Footnote 8]
See 1 Mertens, Law of Federal Income Taxation (1942) §
9.33.
[
Footnote 9]
(Italics supplied.)
See Paul, Selected Studies in
Federal Taxation (Second Series, 1938) 193-95.
[
Footnote 10]
Boske v. Comingore, 177 U. S. 459,
177 U. S. 470;
Brewster v. Gage, 280 U. S. 327,
280 U. S. 336;
United States v. Kirby Lumber Co., 284 U. S.
1,
284 U. S. 3;
Fawcus Machine Co. v. United States, 282 U.
S. 375,
282 U. S. 378.
It may also be noted that the regulation has the support of the
doctrine that reenactment of the statute without disapproval of
regulations thereunder gives them added sanction.
United States
v. Dakota-Montana Oil Co., 288 U. S. 459,
288 U. S. 466;
Helvering v. Winmill, 305 U. S. 79,
305 U. S. 83;
Helvering v. Griffiths, 318 U. S. 371,
318 U. S.
395-397.