In determining the applicability of § 533(a) of the Internal
Revenue Code of 1954 -- which provides a rebuttable presumption
that a corporation that has accumulated earnings "beyond the
reasonable needs of the business" did so with "the purpose to avoid
the income tax with respect to shareholders" -- listed and readily
marketable securities owned by the corporation and purchased out of
its earnings and profits are to be taken into account not at their
cost to the corporation, but at their net liquidation value. Pp.
422 U. S.
624-635.
493 F.2d 426, affirmed.
BLACKMUN, J., delivered the opinion of the Court, in which
BURGER, C.J., and BRENNAN, WHITE, MARSHALL, and REHNQUIST, JJ.,
joined. POWELL, J., filed a dissenting opinion, in which DOUGLAS
and STEWART, JJ., joined,
post, p.
422 U. S.
635.
MR. JUSTICE BLACKMUN delivered the opinion of the Court.
Sections 531-537, inclusive, of the Internal Revenue Code of
1954, as amended, 26 U.S.C. §§ 531-537, constitute
Page 422 U. S. 618
Part I of subchapter G of the Income Tax Subtitle. These
sections subject most corporations to an "accumulated earnings
tax." Section 531 [
Footnote 1]
imposes the tax upon the "accumulated taxable income" of every
corporation that, as § 532(a) states, [
Footnote 2] is
"formed or availed of for the purpose of avoiding the income tax
with respect to its shareholders . . . by permitting earnings and
profits to accumulate instead of being divided or distributed."
And § 533(a) [
Footnote 3]
provides that
"the fact that the earnings and profits . . . are permitted to
accumulate beyond the reasonable needs of the business shall be
determinative of the purpose to avoid the income tax with respect
to shareholders, unless the corporation
Page 422 U. S. 619
by the preponderance of the evidence shall prove to the
contrary. [
Footnote 4]"
The issue here is whether, in determining the application of §
533(a), listed and readily marketable securities owned by the
corporation and purchased out of its earnings and profits are to be
taken into account at their cost to the corporation or at their net
liquidation value, that is, fair market value less the expenses of,
and taxes resulting from, their conversion into cash.
I
The pertinent facts are admitted by the pleadings or are
stipulated:
The petitioner, Ivan Allen Company (the taxpayer), is a Georgia
corporation incorporated in 1902 and actively engaged in the
business of selling office furniture, equipment, and supplies in
the metropolitan Atlanta area. It files its federal income tax
returns on the accrual basis and for the fiscal year ended June
30.
For its fiscal years 1965 and 1966, the taxpayer paid in due
course the federal corporation income taxes shown on its returns as
filed. Taxable income so reported was $341,045.82 for 1965 and
$629,512.19 for 1966. App. 59, 84. During fiscal 1965, the taxpayer
paid dividends consisting of cash in the amount of $48,945.30 and
870 shares
Page 422 U. S. 620
of Xerox Corporation common that had been carried on its books
at a cost of $6,564.34. During fiscal 1966, the taxpayer paid cash
dividends of $50,267.49; it also declared a 10% stock dividend.
Id. at 56. The dividends paid were substantially less than
taxable income less federal income taxes for those years.
Throughout fiscal 1965 and 1966, the taxpayer owned various
listed and unlisted marketable securities. Prominent among these
were listed shares of common stock and listed convertible
debentures of Xerox Corporation that, in prior years, had been
purchased out of earnings and profits. Specifically, on June 30,
1965, the corporation owned 11,140 shares of Xerox common, with a
cost of $116,701 and a then fair market value of $1,573,525, and
$30,600 Xerox convertible debentures, with a cost to it of $30,625
and a then fair market value of $48,424. On June 30, 1966, the
corporation owned 10,090 shares of Xerox common, with a cost of
$102,479 and a then fair market value of $2,479,617, and the same
$30,600 convertible debentures, with their cost of $30,625 and a
then fair market value of $69,768.
Id. at 55.
According to its returns as filed, the taxpayer's undistributed
earnings as of June 30, 1965, and June 30, 1966, were $2,200,184.77
and $2,360,146.52, respectively.
Id. at 70, 91. The
taxpayer points out that the marketable portfolio assets
represented an investment, as measured by cost, of less than 7% of
its undistributed earnings and of less than 55% of its total
assets. Brief for Petitioner 4.
It is also apparent, however, that the Xerox debentures and
common shares had proved to be an extraordinarily profitable
investment, although, of course, because these securities continued
to be retained, the gains thereon were unrealized for federal
income tax purposes. The debentures had increased in fair market
value more than 50% over cost by the end of June, 1965,
Page 422 U. S. 621
and more than 100% over cost one year later; the common shares
had increased in fair market value more than 13 times their cost by
June 30, 1965, and more than 24 times their cost by June 30,
1966.
Throughout fiscal 1965 and 1966, the taxpayer's two major
shareholders, Ivan Allen Sr. . and Ivan Allen, Jr., respectively
owned 31.20% and 45.46% of the taxpayer's outstanding voting stock.
App. 78, 104.
Following an examination of the taxpayer's federal income tax
returns for fiscal 1965 and 1966, the Commissioner of Internal
Revenue determined that the taxpayer had permitted its earnings and
profits for each of those years to accumulate beyond the reasonable
and reasonably anticipated needs of its business, and that one of
the purposes of the accumulation for each year was to avoid income
tax with respect to its shareholders. Based upon this
determination, the Commissioner assessed against the corporation
accumulated earnings taxes of $77,383.98 and $73,131.87 for 1965
and 1966, respectively.
The taxpayer paid these taxes and thereafter timely filed claims
for refund. The claims were not allowed, and the taxpayer then
instituted this refund suit in the United States District Court for
the Northern District of Georgia.
It is agreed that the taxpayer had reasonable business needs for
operating capital amounting to $1,198,309 and $1,455,222 at the
close of fiscal 1965 and fiscal 1966, respectively.
Id. at
56. It is stipulated, in particular, that, if the taxpayer's
marketable securities are to be taken into account at cost, its net
liquid assets (current assets less current liabilities) at the end
of each of those taxable years, and fully available for use in its
business, were then exactly equal to its reasonable business needs
for operating capital, that is the above-stated figures of
$1,198,309 and $1,455,222. It would follow, accordingly,
Page 422 U. S. 622
that the earnings and profits of the two taxable years had
not been permitted to accumulate beyond the taxpayer's
reasonable and reasonably anticipated business needs within the
meaning of § 533(a), App. 57, and no accumulated earnings taxes
were incurred. It is still further stipulated, however, that, if
the taxpayer's marketable securities are to be taken into account
at fair market value (less the cost of converting them into cash),
as of the ends of those fiscal years, [
Footnote 5] the taxpayer's net liquid assets would then be
$2,235,029 and $3,152,009, respectively.
Id. at 56. From
this, it would follow that the earnings and profits of the two
taxable years had been permitted to accumulate beyond the
taxpayer's reasonable and reasonably anticipated business needs.
Then, if those accumulations had been for "the purpose of avoiding
the income tax with respect to its shareholders," under § 532(a),
accumulated earnings taxes would be incurred.
The issue, therefore, is clear and precise: whether, for
purposes of applying § 533(a), the taxpayer's readily marketable
securities should be taken into account at cost, as the taxpayer
contends, or at net liquidation value, as the Government
contends.
The District Court held that the taxpayer's readily marketable
securities were to be taken into account at cost. Accordingly, it
entered judgment for the petitioner taxpayer.
349 F.
Supp. 1075 (1972). The court observed:
"Corporate taxpayers should not be penalized for
Page 422 U. S. 623
wise investments; they should be allowed to maximize their
capital gains tax advantages in accordance with internal business
policies and stock market conditions, rather than being forced to
sell securities which may have a high value on an arbitrarily
selected date merely because the unrealized fair market value of
the securities on that date would trigger the accumulated earnings
tax."
Id. at 1077. (Footnote omitted.)
The United States Court of Appeals for the Fifth Circuit
reversed. 493 F.2d 426 (1974). It observed:
"[T]he securities involved in the case at bar are of such a
highly liquid character as to be readily available for business
needs that might arise. Thus, the appreciated value of these
securities should be taken into account when determining whether
the corporation has accumulated profits in excess of reasonable
business needs."
"
* * * *"
"This decision does not force the corporation to liquidate these
securities at any time when a sale would be financially unwise, but
only compels the corporation to comply with the proscriptions of
the Code and refrain from accumulating excessive earnings and
profits."
Id. at 428. The case was remanded, as the parties had
agreed, App. 57-58,
"for the additional factual determination [under § 532(a)] of
whether one purpose for the accumulation was to avoid income tax on
behalf of the shareholders."
493 F.2d at 428.
Because this conclusion was claimed by the taxpayer to conflict
in principle with
American Trading & Production Corp. v.
United States, 362 F.
Supp. 801 (Md.1972),
aff'd without published opinion,
474 F.2d 1341 (CA4
Page 422 U. S. 624
1973), [
Footnote 6] and
because of the importance of the issue in the administration of the
accumulated earnings tax, we granted certiorari. 419 U.S. 1067
(1974).
II
Under our system of income taxation, corporate earnings are
subject to tax at two levels. First, there is the tax imposed upon
the income of the corporation. Second, when the corporation, by way
of a dividend, distributes its earnings to its shareholders, the
distribution is subject to the tax imposed upon the income of the
shareholders. Because of the disparity between the corporate tax
rates and the higher gradations of the rates on individuals,
[
Footnote 7] a corporation may
be utilized to reduce significantly its shareholders' overall tax
liability by accumulating earnings beyond the reasonable needs of
the business. Without some method to force the distribution of
unneeded corporate earnings, a controlling shareholder would be
able to postpone the full impact of income taxes on his share of
the corporation's earnings in excess of its needs.
See B.
Bittker & J. Eustice, Federal Income Taxation of Corporations
and Shareholders � 8.01 (3d ed.1971); B. Wolfman, Federal Income
Taxation of Business Enterprise 864 (1971).
In order to foreclose this possibility of using the corporation
as a means of avoiding the income tax on dividends to the
shareholders, every Revenue Act since the adoption of the Sixteenth
Amendment in 1913 has imposed a tax
Page 422 U. S. 625
upon unnecessary accumulations of corporate earnings effected
for the purpose of insulating shareholders. [
Footnote 8]
The Court has acknowledged the obvious purpose of the
accumulation provisions of the successive Acts:
"As the theory of the revenue acts has been to tax corporate
profits to the corporation, and their receipt
Page 422 U. S. 626
only when distributed to the stockholders, the purpose of the
legislation is to compel the company to distribute any profits not
needed for the conduct of its business so that, when so
distributed, individual stockholders will become liable not only
for normal, but for surtax, on the dividends received."
Helvering v. Chicago Stock Yards Co., 318 U.
S. 693,
318 U. S. 699
(1943). This was reaffirmed in
United States v. Donruss
Co., 393 U. S. 297,
393 U. S. 303
(1969).
It is to be noted that the focus and impositions of the
accumulated earnings tax are upon "accumulated taxable income," §
531. This is defined in § 535(a) to mean the corporation's "taxable
income," as adjusted. The adjustments consist of the various items
described in § 535(b), including federal income tax, the deduction
for dividends paid, defined in § 561, and the accumulated earnings
credit defined in § 535(c). The adjustments prescribed by §§ 535(a)
and (b) are designed generally to assure that a corporation's
"accumulated taxable income" reflects more accurately than "taxable
income" the amount actually available to the corporation for
business purposes. This explains the deductions for dividends paid
and for federal income taxes; neither of these enters into the
computation of taxable income. Obviously, dividends paid and
federal income taxes deplete corporate resources, and must be
recognized if the corporation's economic condition is to be
properly perceived. Conversely, § 535(b)(3) disallows, for example,
the deduction, available to a corporation for income tax purposes
under § 243, on account of dividends received; dividends received
are freely available for use in the corporation's business.
The purport of the accumulated earnings tax structure
established by §§ 531-537, therefore, is to determine the
Page 422 U. S. 627
corporation's true economic condition before its liability for
tax upon "accumulated taxable income" is determined. The tax,
although a penalty and therefore to be strictly construed,
Commissioner v. Acker, 361 U. S. 87,
361 U. S. 91
(1959), is directed at economic reality.
It is important to emphasize that we are concerned here with a
tax on "accumulated taxable income," § 531, and that the tax
attaches only when a corporation has permitted "earnings and
profits to accumulate instead of being divided or distributed," §
532(a). What is essential is that there be "income" and "earnings
and profits." This at once eliminates, from the measure of the tax
itself, any unrealized appreciation in the value of the taxpayer's
portfolio securities over cost, for any such unrealized
appreciation does not enter into the computation of the
corporation's "income" and "earnings and profits."
The corporation's readily marketable portfolio securities and
their unrealized appreciation, nonetheless, are of profound
importance in making the entirely discrete determination whether
the corporation has permitted what, concededly, are earnings and
profits to accumulate beyond its reasonable business needs. If the
securities, as here, are readily available as liquid assets, then
the recognized earnings and profits that have been accumulated may
well have been unnecessarily accumulated, so far as the reasonable
needs of the business are concerned. On the other hand, if those
portfolio securities are not liquid, and are not readily available
for the needs of the business, the accumulation of earnings and
profits may be viewed in a different light. Upon this analysis, not
only is such accumulation as has taken place important, but the
liquidity otherwise available to the corporation is highly
significant. In any event, and we repeat -- the tax is directed at
the accumulated taxable income and
Page 422 U. S. 628
at earnings and profits. The tax itself is not directed at the
unrealized appreciation of the liquid assets in the securities
portfolio. The latter becomes important only in measuring
reasonableness of accumulation of the earnings and profits that
otherwise independently exist. What we look at, then, in order to
determine its reasonableness or unreasonableness, in the light of
the needs of the business, is any failure on the part of the
corporation to distribute the earnings and profits it has.
Accumulation beyond the reasonable needs of the business, by the
language of § 533(a), is "determinative of the purpose" to avoid
tax with respect to shareholders unless the corporation proves the
contrary by a preponderance of the evidence. The burden of proof,
thus, is on the taxpayer. A rebuttable presumption is statutorily
imposed. To be sure, we deal here, in a sense, with a state of
mind. But it has been said that the statute, without the support of
the presumption, would "be practically unenforceable. . . ."
United Business Corp. v. Commissioner, 62 F.2d 754, 755
(CA2),
cert. denied, 290 U.S. 635 (1933). What is
required, then, is a comparison of accumulated earnings and profits
with "the reasonable needs of the business." Business needs are
critical. And need, plainly, to use mathematical terminology, is a
function of a corporation's liquidity, that is, the amount of idle
current assets at its disposal. The question, therefore, is not how
much capital of all sorts, but how much in the way of quick or
liquid assets, it is reasonable to keep on hand for the business.
United Block Co. v. Helvering, 123 F.2d 704, 705 (CA2
1941),
cert. denied, 315 U.S. 812 (1942);
Smoot Sand
& Gravel Corp. v. Commissioner, 274 F.2d 495, 501 (CA4),
cert. denied, 362 U.S. 976 (1960) (liquid assets provide
"a strong indication" of the purpose of the accumulation);
Electric Regulator
Page 422 U. S. 629
Corp. v. Commissioner, 336 F.2d 339, 344 (CA2 1964);
Novelart Mfg. Co. v. Commissioner, 52 T.C. 794, 806
(1969),
aff'd, 434 F.2d 1011 (CA6 1970),
cert.
denied, 403 U.S. 918 (1971);
John P. Scripps Newspapers v.
Commissioner, 44 T.C. 453, 467 (1965). [
Footnote 9]
The taxpayer itself recognizes, and accepts, the liquidity
concept as a basic factor, for it
"has agreed that the full amount of its realized earnings
invested in its liquid assets -- their cost -- should be taken into
account in determining the applicability of Section 533(a)."
Brief for Petitioner 15. It concedes that, if this were not so,
"the tax could be avoided by any form of investment of earnings and
profits." Reply Brief for Petitioner 5. But the taxpayer would stop
at the point of cost and, when it does so, is compelled to compare
earnings and profits -- not the amount of readily available liquid
assets, net -- with reasonable business needs.
We disagree with the taxpayer, and conclude that cost is not the
stopping point; that the application of the accumulated earnings
tax, in a given case, may well depend on whether the corporation
has available readily marketable portfolio securities; and that the
proper measure of those securities, for purposes of the tax, is
their net realizable value. Cost of the marketable securities on
the assets side of the corporation's balance sheet would appear to
be largely an irrelevant gauge of the taxpayer's true financial
condition. [
Footnote 10]
Certainly, a
Page 422 U. S. 630
lender would not evaluate a potential borrower's marketable
securities at cost. Realistic financial condition is the focus of
the lender's inquiry. It also must be the focus of the
Commissioner's inquiry in determining the applicability of the
accumulated earnings tax. [
Footnote 11]
This taxpayer's securities, being liquid and readily marketable,
clearly were available for the business needs of the corporation,
and their fair market value, net, was such that, according to the
stipulation, the taxpayer's undistributed earnings and profits for
the two fiscal years in question were permitted to accumulate
beyond the reasonable and reasonably anticipated needs of the
business.
III
Bearing directly upon the issue before us is
Helvering v.
National Grocery Co., 304 U. S. 282
(1938). There, the fact situation was the reverse of the present
case inasmuch as that taxpayer corporation had unrealized losses in
the value of marketable securities it was continuing to hold. After
the Court upheld the accumulated earnings tax against
constitutional attack,
id. at
Page 422 U. S. 631
304 U. S.
286-290, it observed:
"Depreciation in any of the assets is evidence to be considered
by the Commissioner and the Board [of Tax Appeals] in determining
the issue of fact whether the accumulation of profits was in excess
of the reasonable needs of the business."
Id. at
304 U. S. 291.
It went on to hold, however, that such depreciation "does not, as
matter of law, preclude a finding that the accumulation of the
year's profits was in excess of the reasonable needs of the
business."
Ibid. Indeed, the Court held that the evidence
supported the Board's finding that the accumulation of surplus by
the taxpayer was to enable its sole shareholder to escape surtaxes.
It focused on bond and stocks held by the corporation, described
them as in no way related to the business, and concluded that
"there was no need of accumulating any part of the year's earnings
for the purpose of financing the business."
Id. at
304 U. S.
291-292. That language forecloses the present taxpayer's
case.
The precedent of
National Grocery has been applied in
accumulated earnings tax cases, with courts taking into account the
fair market value of liquid, appreciated securities.
Battelstein Investment Co. v. United States, 442 F.2d 87,
89(CA5 1971);
Cheyenne Newspapers, Inc. v. Commissioner,
494 F.2d 429, 434-435 (CA10 1974);
Henry Van Hummell, Inc. v.
Commissioner, 23 T.C.M. 1765, 1779 (1964),
aff'd, 364
F.2d 746 (CA10 1966),
cert. denied, 386 U.S. 956 (1967);
Golconda Mining Corp. v. Commissioner, 58 T.C. 139,
supplemental opinion, 58 T.C. 736, 737-739 (1972),
rev'd on other grounds, 507 F.2d 594 (CA9 1974);
Ready
Paving & Constr. Co. v. Commissioner, 61 T.C. 826, 840-841
(1974).
But see Harry A. Koch Co. v. Vinal, 228 F.
Supp. 782, 784 (Neb.1964).
American Trading & Production Corp. v. United
States, 362 F.
Supp. 801 (Md.1972),
aff'd without published
Page 422 U. S. 632
opinion, 474 F.2d 1341 (CA4 1973), which the taxpayer
continues to assert is in conflict with the present case, deserves
mention. The taxpayer there had accumulated earnings and profits of
something less than $10 million. Its anticipated business needs
were about $12 million. But it owned stocks, primarily oil shares,
having a total cost of $5,593,319 and an aggregate current market
value in excess of $100 million. The District Court excluded these
stocks in making its determination whether earnings had accumulated
in excess of reasonable business needs. It did so on several
grounds: that the shares constituted "original capital," a term the
court used in the sense that the stocks
"were properly held and retained as an integral part of [the
taxpayer's] business, and were utilized . . . as a base for
borrowings for the needs of other parts of its business,"
362 F. Supp. at 810; that the statute was not intended to
require the conversion of assets of that kind into cash in order to
meet business needs, even though that capital "has explosively
increased in value,"
id. at 808; and that "there was
substantial evidence" that the stocks "were not readily saleable,"
id. at 809.
Whatever may be the merit or demerit of the other grounds
asserted by the District Court in
American Trading -- and
we express no view thereon -- we are satisfied that the court's
determination as to the absence of ready salability, under all the
circumstances, provides a sufficient point of distinction of that
case from this one, so that it provides meager, if any, contrary
precedent of substance to our conclusion here.
IV
The arguments advanced by the taxpayer do not persuade us:
1. The taxpayer, of course, quite correctly insists that
Page 422 U. S. 633
unrealized appreciation of portfolio securities does not enter
into the determination of "earnings and profits," within the
meaning of § 533(a). As noted above, we agree. The Government does
not contend otherwise. It does not follow, however, that unrealized
appreciation is never to be taken into account for purposes of the
accumulated earnings tax.
As has been pointed out, the tax is imposed only upon
accumulated taxable income, and this is defined to mean taxable
income as adjusted by factors that have been described. The
question is not whether unrealized appreciation enters into the
determination of earnings and profits, which it does not, but
whether the accumulated taxable income, in the determination of
which earnings and profits have entered, justifiably may be
retained, rather than distributed as dividends. The tax focuses,
therefore, on current income and its retention or distribution. If
the corporation has freely available liquid assets in excess of its
reasonable business needs, then accumulation of taxable income may
be unreasonable, and the tax may attach. Utilizable availability of
the portfolio assets is measured realistically only at net
realizable value. The fact that this value is not included in
earnings and profits does not foreclose its being considered in
determining whether the corporation is subject to the accumulated
earnings tax.
2. We see nothing in the "realization of income" concept of
Eisner v. Macomber, 252 U. S. 189
(1920), that has significance for the issue presently under
consideration. There, the Court held that a dividend of common
shares issued by a corporation having only common outstanding was
not includable in the shareholder's gross income for income tax
purposes. The decision may have prompted the shift, noted above and
effected by the Revenue Act of 1921, of the incidence of the
accumulated
Page 422 U. S. 634
earnings tax from the shareholders to the corporation. The case
also emphasizes the realization of income with respect to a tax on
the shareholder. We note again, however, that the accumulated
earnings tax is not on unrealized appreciation of the portfolio
securities. It rests upon, and only upon, the corporation's current
taxable income adjusted to constitute "accumulated taxable
income."
3. The taxpayer also argues that the effect of the Court of
Appeals decision is to force the taxpayer to convert its
appreciated assets in order to meet its business needs. It suggests
that management should be entitled to finance business needs
without resorting to unrealized appreciation. The argument,
plainly, goes too far. On the taxpayer's own theory that marketable
securities may be taken into account at their cost, a situation
easily may be imagined where some conversion into cash becomes
necessary if the corporation is to avoid the accumulated earnings
tax.
That our decision does not interfere with corporate management's
exercise of sound business judgment, and that it does not amount to
a dictation to management as to when appreciated assets are to be
liquidated, was aptly answered by the Court of Appeals:
"This decision does not force the corporation to liquidate these
securities at any time when a sale would be financially unwise, but
only compels the corporation to comply with the proscriptions of
the Code and refrain from accumulating excessive earnings and
profits. That taxpayer, as a consequence of its own sound judgment
in making profitable investments, must sell, exchange or distribute
to the shareholders assets in order to avoid an excessive
accumulation of earnings, and thus comply with the Code's
Page 422 U. S. 635
requirements is no justification for precluding its
application."
493 F.2d at 428.
We might add that the existence of the Code's provisions for the
accumulated earnings tax, of course, will affect management's
decision. So, too, does the very existence of the corporate income
tax itself. In this respect, the one is no more offensive than the
other. Astute management in these tax-conscious days is not that
helpless, and shrinkage, upon liquidation, of one-fourth of the
appreciation hardly equates with loss. Such business decision as is
necessitated was expressly intended by the Congress. All that is
required is the disgorging, at the most, of the taxable year's
"accumulated taxable income."
4. It is no answer to suggest that our decision here may
conflict with standard accounting practice. The Court has not
hesitated to apply congressional policy underlying a revenue
statute even when it does conflict with an established accounting
practice.
See, e.g., Schlude v. Commissioner, 372 U.
S. 128 (1963);
American Automobile Assn. v. United
States, 367 U. S. 687,
367 U. S.
692-694 (1961). It is of some interest that the taxpayer
itself, for the tax years under consideration, reflected the market
value as well as the cost of its marketable securities on its
balance sheets. App. 112, 118. This appears to be in line with
presently accepted practice.
See R. Kester, Advanced
Accounting 117-118, 122-124 (4th ed.1946).
The judgment of the Court of Appeals is affirmed.
It is so ordered.
[
Footnote 1]
"§ 531. Imposition of accumulated earnings tax."
"In addition to other taxes imposed by this chapter, there is
hereby imposed for each taxable year on the accumulated taxable
income (as defined in section 535) of every corporation described
in section 532, an accumulated earnings tax equal to the sum of --
"
"(1) 27 1/2 percent of the accumulated taxable income not in
excess of $100,000, plus"
"(2) 38 1/2 percent of the accumulated taxable income in excess
of $100,000."
[
Footnote 2]
"§ 532. Corporations subject to accumulated earnings tax."
"(a) General rule."
"The accumulated earnings tax imposed by section 531 shall apply
to every corporation (other than those described in subsection (b))
formed or availed of for the purpose of avoiding the income tax
with respect to its shareholders or the shareholders of any other
corporation, by permitting earnings and profits to accumulate
instead of being divided or distributed."
[
Footnote 3]
"§ 533. Evidence of purpose to avoid income tax."
"(a) Unreasonable accumulation determinative of purpose."
"For purposes of section 532, the fact that the earnings and
profits of a corporation are permitted to accumulate beyond the
reasonable needs of the business shall be determinative of the
purpose to avoid the income tax with respect to shareholders,
unless the corporation by the preponderance of the evidence shall
prove to the contrary."
[
Footnote 4]
In a proceeding before the United States Tax Court, § 534 allows
the taxpayer to shift the burden of proof to the Commissioner of
Internal Revenue. Section 535 defines "accumulated taxable income"
to mean the corporation's taxable income adjusted as specified; a
credit is given for "such part of the earnings and profits for the
taxable year as are retained for the reasonable needs of the
business," with a minimum "lifetime" credit of $100,000 ($150,000
for taxable years beginning after December 31, 1974), Pub.L. 94-12,
§ 304, 89 Stat. 45, 26 U.S.C. § 535(c)(2) (1970 ed., Supp. IV).
Finally, § 537 provides that the term "reasonable needs of the
business" includes "the reasonably anticipated needs of the
business."
[
Footnote 5]
It is stipulated that the cost of converting the taxpayer's
marketable securities into cash would have been the sum of a
maximum of 6% of the fair market value of the securities (payable
as a brokerage commission) and a maximum of 25% of such amount of
the fair market value as exceeds the sum of the brokerage
commission and the cost of the securities (payable as capital gains
taxes). App. 55.
[
Footnote 6]
American Trading and Production Corporation, pursuant to our
Rule 42, was granted permission to file a brief as
amicus
curiae in the present case. It asserts that no conflict exists
between the decisions in this case and in its own case.
[
Footnote 7]
The income tax rates for a corporation are 22% of the first
$25,000 of taxable income and 48% of the excess over $25,000. § 11
of the 1954 Code, 26 U.S.C. § 11. The graduated rates for an
individual taxpayer range from 14% to 70%. § 1, 26 U.S.C. § 1.
[
Footnote 8]
The accumulated earnings tax originated in § IIA, Subdivision 2,
of the Tariff Act of October 3, 1913, 38 Stat. 166. This imposed a
tax on the shareholders of a corporation
"formed or fraudulently 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."
Accumulations "beyond the reasonable needs of the business shall
be
prima facie evidence of a fraudulent purpose to escape
such tax."
Id. at 167. The same provision appeared as § 3
of the Revenue Act of 1916, 39 Stat. 758, and again as § 220 of the
Revenue Act of 1918, 40 Stat. 1072 (1919), except that, in the 1918
Act, the word "fraudulently" was deleted. This change was effected
inasmuch as the Senate felt that the former phraseology "has proved
to be of little value, because it was necessary to its application
that intended fraud on the revenue be established in each case."
S.Rep. No. 617, 65th Cong., 3d Sess., 5 (1918).
This pattern of tax on the shareholders was changed with the
Revenue Act of 1921, § 220, 42 Stat. 247. The incidence of the tax
was shifted from the shareholders to the corporation itself. Judge
Learned Hand opined that the change was due to doubts "as to the
validity of taxing income which the taxpayers had never received,
and, in 1921, it was thought safer to tax the company itself."
United Business Corp. v. Commissioner, 62 F.2d 754, 756
(CA2),
cert. denied, 290 U.S. 635 (1933).
Although the statutory language has varied somewhat from time to
time, the income tax law, since the change effected by the Revenue
Act of 1921, consistently has imposed the tax on the corporation,
rather than upon the shareholders. Revenue Act of 1924, § 220, 43
Stat. 277; Revenue Act of 1926, § 220, 44 Stat. 34; Revenue Act of
1928, § 104, 45 Stat. 814; Revenue Act of 1932, § 104, 47 Stat.195;
Revenue Act of 1934, § 102, 48 Stat. 702; Revenue Act of 1936, §
102, 49 Stat. 1676; Revenue Act of 1938, § 102, 52 Stat. 483;
Internal Revenue Code of 1939, § 102.
[
Footnote 9]
In this case, we are concerned only with readily marketable
securities. We express no view with respect to items of a different
kind, such as inventory or accounts receivable.
[
Footnote 10]
"The tax should be administered with its purpose in mind at all
times,
i.e., to prevent accumulations of income by the
corporation for the purpose of avoiding the income tax ordinarily
incident to the shareholders. It is not intended to serve as an
obstacle to sound profit-oriented corporate management. The
ultimate goal must be to administer the tax fairly, in light of the
total economic reality of the corporation. Valuing liquid assets at
cost invariably produces a poor and inaccurate picture of the
corporate financial position. Adjusted fair market value may have
shortcomings of its own, but it does, undeniably, come much closer
to furthering the intent of the accumulated earnings tax."
Note, Accumulated Earnings Tax: Should Marketable Securities be
Valued at Cost or at Fair Market Value in Determining the
Reasonableness of Further Accumulations of Income?, 40 Brooklyn
L.Rev.192, 209-210 (1973).
[
Footnote 11]
We see little force in any observation that our emphasis on
liquid assets means that a corporate taxpayer may avoid the
accumulated earnings tax by merely investing in nonliquid assets.
If such a step, in a given case, amounted to willful evasion of the
accumulated earnings tax, it would be subject to criminal
penalties.
See, e.g., § 7201 of the 1954 Code, 26 U.S.C. §
7201.
MR. JUSTICE POWELL, with whom MR. JUSTICE DOUGLAS and MR.
JUSTICE STEWART join, dissenting.
The Court's decision departs significantly from the relevant
statutory language, creates a rule of additional
Page 422 U. S. 636
tax liability that places business management in a perilous
position, and vests in the Internal Revenue Service an
inappropriate degree of discretion in administering a punitive
statute. I therefore dissent.
I
Petitioner, a corporation with 34 stockholders, is engaged in
selling office supplies and equipment. In the late 1950's, because
petitioner was a retail outlet for equipment of the Xerox Corp., it
invested $147,000 of its earnings and profits in securities of
Xerox. The market value of that investment increased substantially
over the years, and by the end of petitioner's 1965 and 1966 tax
years, the unrealized market appreciation [
Footnote 2/1] of those securities approximated
$1,475,000 and $2,416,000 respectively. [
Footnote 2/2] For the purpose of determining the
applicability of the additional penalty tax liability under 26
U.S.C. § 531, the Commissioner valued these securities at their
year-end market price. He thereupon assessed the tax here at
issue.
The question is one of statutory construction: in determining
whether a corporation has accumulated earnings and profits in
excess of reasonable business needs within the meaning of 26 U.S.C.
§ 533(a), are assets purchased with earnings and profits to be
valued at the amount invested in them -- their cost -- or at their
market
Page 422 U. S. 637
price, [
Footnote 2/3] which
reflects both cost and unrealized appreciation? The question has
not heretofore been decided by this Court, and has been considered
infrequently by other federal courts.
II
I address first the statutory language, which, in my view, is
controlling. Section 531 imposes a tax "[i]n addition to other
taxes imposed by this chapter . . . on the accumulated taxable
income . . . of every corporation" identified by § 532. Section 532
makes the § 531 tax applicable to every corporation
"formed or availed of for the purpose of avoiding the income tax
with respect to its shareholders . . . by permitting earnings and
profits to accumulate instead of being divided or distributed."
If "the earnings and profits of a corporation are permitted to
accumulate" beyond its reasonable needs, § 533 establishes a
rebuttable presumption that the corporation is one "formed or
availed of for the purpose of avoiding the income tax," and that it
is therefore liable for the § 531 tax.
The central element of this statutory scheme is the unreasonable
accumulation of earnings and profits beyond the corporation's
reasonable needs. It is stipulated in this case that there is no
unreasonable accumulation and no additional tax unless the
unrealized appreciation of the Xerox securities is added to
petitioner's actual accumulated earnings and profits
(
i.e., to its earned surplus
Page 422 U. S. 638
account). [
Footnote 2/4] Under
normal concepts of tax law and accounting, the Government's
position is therefore untenable on its face. Unrealized
appreciation of assets is not considered in computing ordinary
corporate or individual taxable income. Indeed, sound accounting
practice requires that assets be recorded and carried at cost,
[
Footnote 2/5] and this requirement
is enforced with respect to filings with the Securities and
Exchange Commission (SEC). Similarly, if assets of a corporation
are distributed to shareholders "in kind," the company is credited
for a dividend payment only on the basis of the cost of those
assets, not their appreciated value.
In view of this unanimity of law and practice, what theory is
devised by the Government and the Court today as justification for
a different rule for this penalty tax? I look to the Court's
opinion for the answer. It is conceded that "unrealized
appreciation does not enter into the computation of the
corporation's . . . [accumulated]
earnings and profits.'"
Ante at 422 U. S. 627.
Nevertheless,
Page 422 U. S. 639
the Court holds that such appreciation "becomes important" and
must be taken into account "in measuring [the] reasonableness" of
such accumulation.
Ante at
422 U. S. 628.
In short, the Court construes the statute to mean that, although
unrealized appreciation is not includable in computing earnings and
profits, it is includable in determining whether earnings and
profits have been accumulated unreasonably.
The statute provides no basis whatever for this distinction.
According to its own terms, selected with full knowledge of
accepted tax and accounting principles, the penalty tax applies
only if there is an unreasonable accumulation of
earnings and
profits; the statute contains no reference to the addition of
unrealized appreciation to the accumulated earnings and profits
which constitute the only basis for imposing the tax. Nor does the
history or purpose of the statute support the "add on" of an
unrealized increment of value conceded by the Court to be neither
earnings nor profits. By authorizing this "add on," the Court's
decision effectively converts the tax on excessive accumulation of
earnings and profits to a tax on the retention of certain assets
that appreciate in value. Although current accumulated taxable
income remains the measure of the tax, its application in many
cases will be controlled simply by the existence of unrealized
appreciation in the value of these assets.
The purpose of the statute, as the Court states, is "to force
the distribution of unneeded corporate earnings."
Ante at
422 U. S. 624.
Such a distribution is accomplished by the payment of dividends,
which normally are declared and paid only out of current earnings
or earned surplus, determined in accordance with sound accounting
practice. Absent authorization in a statute or corporate charter,
corporate directors who pay dividends from unrealized
Page 422 U. S. 640
appreciation risk personal liability at the suit of stockholders
or injured creditors. [
Footnote
2/6]
III
The plain language of the Code resolves this case for me. But
even if the statute could be thought ambiguous
Page 422 U. S. 641
on the point, the tax is, as the Court concedes, a "penalty, and
therefore [must] be strictly construed. . . ."
Ante at
422 U. S. 627.
See Commissioner v. Acker, 361 U. S.
87,
361 U. S. 91
(1959). This means, at a minimum, that doubts and ambiguities must
be resolved in favor of a fair and equitable construction that is
as free from the hazards of uncertainty as the statutory language
and purpose will allow. It seems to me that the Court's opinion
ignores the meaning of this canon of construction. Rather than
construe the statute narrowly, today's decision extends the
presumptive reach of this tax beyond the language of the Code and
creates a number of perplexing uncertainties.
Businesses normally are conducted, and management decisions
made, on the basis of financial information that is maintained in
accordance with sound accounting practice. The most elementary
principle of accounting practice is that assets are recorded at
cost. This is true with respect to the computation of earnings and
profits, payment of ordinary corporate taxes, determination of
dividend policy, and reporting to stockholders, the SEC, and other
regulatory agencies. Corporate books and records are audited only
on that basis. Whatever may be said for the Court's view of the
"unreality" of adhering to the principles of sound accounting
practice,
ante at
422 U. S. 629-630, those principles are the best system
yet devised for guiding management, informing shareholders, and
determining tax liability. They have the not inconsiderable virtues
of consistency, regularity, and certainty -- virtues that also
assure fairness and reasonable
Page 422 U. S. 642
predictability in the Commissioner's administration of this
penalty tax.
The Court today abandons accounting principles confirmed by the
wisdom of business experience and announces a new rule with
far-reaching consequences. In my view, this rule will create
uncertainty and open wide possibilities for unfairness.
A
Both taxpayers and the Government know what is meant by "cost
basis," and a corporation's earned surplus account, which reflects
accumulated earnings and profits from which dividends normally are
paid, is an established accounting fact. There is no comparable
certainty or dependability in the rule devised by the Court:
"Cost of the marketable securities on the assets side of the
corporation's balance sheet would appear to be largely an
irrelevant gauge of the taxpayer's
true financial condition. .
. . Realistic financial condition is the focus . . . of the
Commissioner's inquiry in determining the applicability of the
accumulated earnings tax."
Ante at 629-630 (emphasis added).
In this case, involving marketable securities, the computation
of the true value for purposes of the tax appears at first blush to
present no serious problem of uncertainty. The Court simply equates
market price at the end of the tax year with true value, and adds
the resulting excess over cost to the book value of the securities.
Apart from the questionable assumption that market quotations
represent the true value of a retained common stock, the Court's
new formulation poses perplexing definitional questions for
management.
An initial uncertainty results from the Court's ambiguous use of
the term "securities." As defined in the
Page 422 U. S. 643
Securities Act of 1933 and the Securities Exchange Act of 1934,
the term is quite comprehensive. [
Footnote 2/7] Even so, its meaning is not always
self-evident, as can be seen by examining some of the extensive
litigation on this question.
See, e.g., 1050 Tenants Corp. v.
Jakobson, 503 F.2d 1375 (CA2 1974);
SEC v. Glenn W. Turner
Enterprises, Inc., 474 F.2d 476 (CA9),
cert. denied,
414 U.S. 821 (1973);
Lehigh Valley Trust Co. v. Central
National Bank of Jacksonville, 409 F.2d 989 (CA5 1969).
In addition, uncertainties will arise in ascertaining whether
the asset is sufficiently "readily marketable" to satisfy the
Court's test. The Court attaches significance to whether the
security is "listed" on a stock exchange. It is indeed true that
the great majority of common stocks listed on the New York Stock
Exchange are readily marketable, unless the number of shares to be
sold is too large for the market to absorb. The same cannot be
said, however, of all bonds listed on that Exchange. Moreover,
there are other exchanges on which securities are listed and
traded: the American Stock Exchange, over the counter, and scores
of local exchanges. While many securities traded on these exchanges
may be "readily marketable," perhaps the majority could not fairly
be so characterized. In countless situations, corporate management
will be unable to determine, short of attempting to sell the
security, whether it is "readily marketable" or not.
Page 422 U. S. 644
B
The uncertainty engendered by today's opinion will not be
limited to its undifferentiated treatment of marketable securities.
A more fundamental question arising from the rationale of the
Court's decision is whether the test of "true" or "realistic"
financial condition will be applied to other assets. Nothing in the
relevant statutory provisions suggests a distinction between
securities and other assets, or even between assets with varying
degrees of marketability. The Court nevertheless appears to read
into the statutes a distinction based on "liquidity," at various
points referring interchangeably to "readily marketable
securities," "current assets," and "quick or liquid assets."
Ante at
422 U. S. 622,
422 U. S. 628.
Although the Court's holding is limited in this case to readily
marketable securities,
see ante at
422 U. S. 629
n. 9, its rationale is not so easily contained.
The Court states categorically that the "focus" of the
Commissioner's inquiry, in determining the application of this tax,
must be on what it calls true or realistic financial condition.
Ante at
422 U. S.
629-630. In view of this postulation, and the absence of
any distinction in the statute among types of assets, is the
Commissioner now free to include in his computation the unrealized
appreciation of all corporate assets? Once cost basis is abandoned,
and "realistic" value becomes the standard, the uncertainties
confronting prudent management in many cases will be profoundly
disquieting. To be sure, read narrowly, the Court's decision
applies only to readily marketable securities, with emphasis on
"liquidity." But this is another relative term, depending on the
nature of the asset and the uncertainties of market conditions at
the time.
The potential sweep of the Court's decision is forecast by the
response of Government counsel to questions
Page 422 U. S. 645
about unrealized appreciation on real estate. At one point
counsel stated that real estate would not be sufficiently liquid to
be includable at market value in the tax calculation, Tr. of Oral
Arg. 36, but he later qualified this statement by suggesting that
land might be includable if it could be established that it was
readily marketable,
id. at 42. [
Footnote 2/8]
The types of assets in which corporations lawfully may invest
earnings and profits embrace the total range of property interests.
They include, to name only a few examples, unimproved real estate
within the anticipated growth pattern of a major urban area,
improved real estate, unlisted securities of growth corporations
that have not "gone public," undivided interests in oil or mining
ventures, and even objects of art. At various times and depending
upon conditions, any of these assets may be viewed as -- and, in
fact, may be readily marketable and therefore "liquid." The
unrealized appreciation of such assets may well bear upon the
realistic financial condition of a corporation, however it is
defined. In light of these economic facts, the sweep of today's
decision presents problems both for corporate taxpayers and the
Government. [
Footnote 2/9]
Page 422 U. S. 646
C
I further think that the Court's decision to attach significant
tax consequences to the market price of a volatile stock at a
particular point in time will lead to unfairness in the application
of the accumulated earnings tax. The Court's net liquidation
formulation seems to assume, and nothing in the opinion dispels
this assumption, that readily marketable assets are to be valued as
of the end of the tax year in question. Moreover, the Court
apparently would treat all marketable securities the same for the
purpose of this valuation. No distinction is drawn or even
suggested among the wide variety of securities that are held as
corporate assets.
The market price of a short-term Treasury note, at most only
fractionally different from its cost basis, would represent its
value under any test. But few financial analysts or economists
would say that the market quotation of a common stock at any
particular time necessarily
Page 422 U. S. 647
reflects its "true" or "realistic" value unless the stock is
sold at that price. [
Footnote
2/10] Over a sufficiently long-term, the market price of a
common stock will reflect, and vary with, the fundamental strength
of the issuing corporation's balance sheet, its earnings record,
and its future earnings prospects. But a variety of other factors
also affect market price, producing wide swings that do not
necessarily correspond to those economic facts. These factors
include current conditions of supply and demand in the stock
market, immediate confidence in the market in general and in the
overall state of the economy, international stability or
instability, notions of what is fashionable to buy at a particular
time, and a variety of other intangibles. The extent to which the
market prices of common stocks fluctuate, often without regard to
any concept of "real" value, is illustrated by the tables in the
422
U.S. 617appa1|>Appendices to this opinion.
Bearing in mind the actual variations in the price of
Page 422 U. S. 648
Xerox stock, can it be said that its market price at any given
time fairly represents its true or realistic value for the purpose
of determining whether earnings and profits have been accumulated
unreasonably? The negative answer to this question is indicated, at
least for me, by the following hypothetical example. In 1965, one
of the tax years at issue in this case, the highest price at which
Xerox sold was $71 and the lowest was $31. If two competing
corporations each owned 10,000 shares of Xerox stock purchased
prior to 1965 at the identical price of $31 per share, and
Corporation A's tax year ended on the day that Xerox hit $71, while
Corporation B's tax year ended on the day it hit $31, Corporation A
would have had an unrealized appreciation of $400,000, whereas
Corporation B would have had none.
By departing from the cost basis standard of sound accounting
practice, and compelling reliance on an isolated market price of a
retained common stock, the Court itself departs from its avowed
goal of "economic reality."
Ante at
422 U. S. 627.
An average price range at which the stock might have been sold over
a relatively long period might produce a more equitable result in
some cases. It would not, however, alleviate the basic problem
inherent in the Court's formulation. The taxpayer still could be
penalized for having failed to consider, in planning future
business needs, the highly ephemeral "value" of unrealized
appreciation on common stock. The effect of today's decision is to
hold business management accountable for unrealized appreciation as
if it were cash in hand, probably forcing corporate management in
many cases to liquidate securities that otherwise it would have
elected to retain. [
Footnote
2/11]
Page 422 U. S. 649
Management decisions during the course of a year, including
decisions whether and when to pay dividends and in what amounts,
cannot be made intelligently on the basis of an asset so volatile
that it may depreciate in market value as much as 8% in a single
day and 61% in a year. Uncertainty of this magnitude could only be
avoided by liquidation of assets that have appreciated in value. I
find nothing in the language or purpose of this tax that justifies
such detrimental interference with sound corporate management.
IV
The Court places major reliance on
Helvering v. National
Grocery Co., 304 U. S. 282
(1938), finding that that opinion "forecloses the present
taxpayer's case."
Ante at
422 U. S. 631.
I respectfully suggest that the Court's interpretation of National
Grocery will not withstand close scrutiny of the facts or its
actual holding. [
Footnote
2/12]
Page 422 U. S. 650
National Grocery, its stock owned by a sole shareholder, was
organized in 1908 with an authorized capital of $5,000; its
business prospered over the years, so that, by January 31, 1931
(the taxable year there at issue), its earned surplus was
$7,939,000. These earnings notwithstanding, National Grocery's
"only dividends . . . ever paid . . . up to January 31, 1931, were
a dividend of $25,000 in 1917, and a dividend of a like amount in
1918."
National Grocery Co. v. Commissioner, 35 B.T.A.
163, 164 (1936). The corporation's net profits for the four fiscal
years preceding fiscal year 1931, all of which were retained,
rather than distributed, averaged in excess of $800,000 annually.
National Grocery earned some $864,000 during the tax year in
question, none of which was distributed as a dividend. Addressing
the taxpayer's attempt to offset the depreciation of some of its
assets, the Court noted:
"Depreciation in any of the assets is evidence to be considered
by the Commissioner and the Board in determining the issue of fact
whether the accumulation of profits was in excess of the reasonable
needs of the business. But obviously depreciation in the market
value of securities which the corporation continues to hold does
not, as matter of law, preclude a finding that the accumulation of
the year's profits was in excess of the reasonable needs of the
business."
304 U.S. at
304 U. S. 291.
When
National Grocery is read in light of the facts and
issues there presented -- as it must be in order to understand the
Court's passing statement -- it is readily apparent that the
holding in that case does not govern the issue here. The central
issue there was the
Page 422 U. S. 651
definition of "gains and profits": specifically, whether
"gains," a term replaced in the present statute by "earnings,"
qualified the meaning of "profits." The Court apparently felt
justified in devoting little attention to the issue, for it was
plain in light of the huge accumulation of earnings over time that
the taxpayer would be liable even if it were allowed to offset the
asserted depreciation. Finally, it is significant that National
Grocery's "accumulation of earnings" was computed on the basis of
book value or cost. Indeed, all of the relevant figures were so
computed, including the $7,393,000 surplus that had been
accumulated over time.
I therefore find no justification for the view that
National
Grocery forecloses consideration of the question here
presented. Moreover, even if I could agree with the Court's
interpretation of that case, I would refuse to follow a rationale
so plainly at odds with the statutory language and so conducive to
uncertainty and unfairness.
V
The uncertainties the Court has now read into this penal statute
correspondingly vest in the Internal Revenue Service an
inappropriate latitude in its administration. In light of today's
decision, the Commissioner will have wide and virtually
uncontrolled discretion in deciding which corporations will be
subject to additional taxation, or at least in deciding which will
be required to rebut the presumption that earnings were accumulated
to evade shareholder tax liability. Until today's decision,
management, in trying to anticipate what a Commissioner would deem
an unreasonable accumulation, at least could rely on the
corporation's earned surplus account as establishing its
accumulated earnings and profits. Now this dependable benchmark has
become an "irrelevant gauge" of a corporation's "true financial
condition,"
Page 422 U. S. 652
and, in many cases, management can only speculate about the
Commissioner's future determination of values nowhere reflected in
the corporation's books. As commentators have noted,
see
B. Bittker & J. Eustice, Federal Income Taxation of
Corporations and Shareholders � 8.01, p. 8 (3d ed.1971), the
decision to impose the accumulated earnings tax inevitably involves
"a hindsight verdict on management's business judgment." The
Court's decision does not impose identifiable standards on the
Commissioner's exercise of this extraordinary "hindsight"
authority, but leaves it open-ended. It is unlikely, to say the
least, that Congress intended to leave small and medium-sized
businesses -- those most often the target of this tax exposed to
this degree of administrative discretion in the imposition of a
potentially heavy penalty tax.
Page 422 U. S. 653
|
422
U.S. 617appa1|
bwm:
APPENDIX A-1 TO OPINION OF POWELL, J., DISSENTING
The volatility and transient character of
market prices of a common stock are illustrated
by the following tables:*
TABLE I XEROX CORP. COMMON STOCK**
% Change
High Low High to Low
---- --- -----------
Fluctuations in a
single day:
June 14, 1965. . . . 48.25 45 - 6.7
May 16, 1975 . . . . 87 78.50 - 9.8
Fluctuations in a
single month:
November 1965. . . . 66.50 57.50 - 13.6
August 1974. . . . . 98 74.25 - 24.2
Fluctuations in a
single year:
1965 . . . . . . . . 71 31 - 56.3
1974 . . . . . . . . 127 49 -61.4
* Except as noted, all data in this Appendix
were taken from published New York Stock Exchange
quotations. The information presented here is
selective, and presented for illustrative purposes.
** All Xerox quotations take into account the
1965 three-for-one split.
Page 422 U. S. 654
APPENDIX A-2 TO OPINION OF POWELL, J., DISSENTING
TABLE II
SELECTED STOCK RANGES DURING 1965*
Percent Percent
Change Change Change
Open to High to Open to
Name of Company High Low Close Close Low Close
--------------- ------- ------ ------- -------- ------
-------
Chrysler Corp. . . . . . . . . . 62 l/4 41 5/8 53 3/8 - 7 5/8
-33.1% - 12.5%
Fairchild Camera . . . . . . . . 165 l/4 27 1/4 150 1/2 +123
-83.5% +447.3%
Financial Federation . . . . . . 37 1/4 19 5/8 23 7/8 - 13 1/8
-47.3% - 35.5%
General Dynamics . . . . . . . . 68 l/4 35 56 3/4 + 21 3/4
-48.7% + 62.1%
W. T. Grant. . . . . . . . . . . 62 l/4 35 7/8 62 1/4 + 25 3/4
-42.4% + 70.5%
Grolier, Inc. . . . . . . . . . 60 1/2 37 55 3/4 -- -38.8%
--
Gulf & Western Ind. . . . . . . 102 31 1/8 92 7/8 + 61 1/8
-69.5% +192.5%
KLM Airlines . . . . . . . . . . 81 7/8 19 3/4 79 + 59 -75.9%
+295.0%
Ling Tempco Vaught . . . . . . . 58 17 l/4 48 1/4 + 30 3/4
-70.3% +175.7%
Pan American Airways . . . . . . 55 5/8 25 l/4 51 1/8 + 22 5/8
-54.6% + 79.4%
Pennsylvania Railroad. . . . . . 65 35 1/8 64 3/8 + 25 3/4
-46.0% + 66.7%
Polaroid Corp. . . . . . . . . . 130 44 1/4 116 5/8 + 70 3/4
-66.0% +154.2%
RCA Corp . . . . . . . . . . . . 50 1/2 31 47 1/4 + 13 3/8
-38.6% + 39.5%
United Airlines. . . . . . . . . 118 5/8 58 5/8 104 3/4 + 45 1/2
-50.6% + 76.8%
White Consolidated Ind. . . . . 49 1/2 17 3/8 48 3/4 + 30 3/4
-64.9% +170.8%
Xerox Corp. . . . . . . . . . . 215 94 7/8 202 +103 3/8 -55.9%
+104.8%
Page 422 U. S. 655
RANGE IN AVERAGES**
12/31/64 High Low 12/31/65
-------- ------ ------ --------
Dow Jones Industrial Average. . . 874.13 969.26 840.59
969.26
Percent Change High to Low . . . -13.3%
Standard & Poor's 500 Index. . . . 84.75 92.63 81.60
92.43
Percent Change High to Low . . . -11.9%
SOME PRICES As OF MAY 12, 1975, OF SELECTED COMPANIES LISTED
ABOVE**
Chrysler Corp. . . . . . . . . . 12 l/4
W. T. Grant. . . . . . . . . . . 9 1/2 (Adjusted for 2 for 1
Split -- 1966)
Grolier, Inc. . . . . . . . . . 6 (Adjusted for 2 for 1 Split --
1966)
Pan American Airways . . . . . . 9 3/4 (Adjusted for 2 for 1
Split -- 1967)
Pennsylvania Central . . . . . . 1 5/8
Polaroid Corp. . . . . . . . . . 63 l/4 (Adjusted for 2 for 1
Split -- 1968)
RCA Corp. . . . . . . . . . . . 17 3/4
UAL, Inc. (United Airlines). . . 42 (Adjusted for 2 for 1 Split
-- 1966)
Xerox Corp. . . . . . . . . . . 258 3/4 (Adjusted for 3 for 1
Split -- 1969)
*Source -- New York Times -- Monday, January 17, 1966 -- for
stock ranges only.
**Prices have been adjusted for additional shares received as a
result of
stock splits.
Page 422 U. S. 656
APPENDIX A-3 TO OPINION OF POWELL, J., DISSENTING
TABLE III
SELECTED STOCK RANGES DURING 1974*
Percent Percent
Change Change Change
Open to High to Open to
Name of Company High Low Close Close Low Close
--------------- ------- ------- ------- ------- -------
-------
ACF Industries. . . . . . . . . . 61 l/4 28 3/4 33 -24 7/8
-53.0% - 43.0%
Addressograph-Multigraph. . . . . 11 3/4 3 3 3/8 - 6 1/2 -74.5%
- 65.8%
Citizens & Southern Realty. . . . 31 3/4 2 2 5/8 -26 3/4
-93.7% - 91.1%
Chrysler Corp. . . . . . . . . . 20 1/8 7 7 1/4 - 8 3/8 -65.2% -
53.6%
Coca Cola Co. . . . . . . . . . . 127 3/4 44 5/8 53 -73 1/2
-65.1% - 58.1%
Combustion Engineering. . . . . . 106 l/4 21 5/8 26 l/4 -78 3/4
-79.6% - 75.0%
Consolidated Edison . . . . . . . 21 1/2 6 7 1/2 -11 1/4 -72.1%
- 60.0%
Continental Illinois Corp. . . . 59 1/4 23 l/4 26 5/8 -25 l/4
-60.8% - 48.7%
Cousins Mortgage. . . . . . . . . 23 3/4 l l/8 1 3/8 -18 7/8
-95.3% - 93.2%
E. I. duPont. . . . . . . . . . . 179 84 1/2 92 1/4 -66 3/4
-52.8% - 42.4%
Eastman Kodak . . . . . . . . . . 117 1/2 57 5/8 62 7/8 -53 1/8
-51.0% - 45.8%
Fidelity Mtge. Invest. . . . . . 10 l/4 9/16 15/16 - 5 15/16
-94.5% - 86.4%
Foster Wheeler. . . . . . . . . . 64 1/2 13 15 1/8 -45 -79.8% -
74.8%
Holly Sugar . . . . . . . . . . . 39 12 l/8 26 l/4 +13 3/4
-68.9% +110.0%
Honeywell, Inc. . . . . . . . . . 86 1/4 17 1/2 21 -49 1/8
-79.7% - 70.1%
Page 422 U. S. 657
Moore McCormack Resources . . . . 34 1/4 12 3/8 28 1/2 +15 3/4
-63.9% +123.5%
RCA Corp. . . . . . . . . . . . . 21 1/2 9 1/4 10 3/4 - 7 3/4
-57.0% - 41.9%
Stone & Webster . . . . . . . . . 89 7/8 31 1/2 33 3/8 -56
-65.0% - 62.7%
Tri South Mtge. Investors . . . . 27 1/4 2 2 3/4 -21 1/8 -92.7%
- 88.5%
Union Camp Corp. . . . . . . . . 63 37 1/4 38 7/8 -20 3/8 -40.9%
- 34.4%
Union Carbide . . . . . . . . . . 46 31 3/4 41 3/8 + 7 1/4
-31.0% + 21.3%
Xerox Corp. . . . . . . . . . . . 127 1/8 49 51 1/2 -71 1/4
-61.5% - 58.0%
Great Western United. . . . . . . 31 1/4 3 1/8 24 1/4 +20 3/4
-90.0% +592.9%
Great American Mortgages. . . . . 32 1 l 1/8 -28 7/8 -98.8% -
96.3%
RANGE IN AVERAGES*
12/31/73 High Low 12/31/74
-------- ------ ------ --------
Dow Jones Industrial Average. . . . . . 850.86 891.66 577.60
616.24
Percent Change High to Low. . . . . . -- 35.2%
Standard & Poor's 500 Index. . . . . . . 97.55 99.80 62.28
68.24
Percent Change High to Low. . . . . . -- 37.6%
*Source -- Richmond Times-Dispatch, Sunday, Jan. 5, 1975, pp.
E-6, E-7 --
for stock ranges only.
Page 422 U. S. 658
APPENDIX A-4 TO OPINION OF POWELL, J., DISSENTING
TABLE IV
WALL STREET JOURNAL
Friday, May 16, 1975, p. 33
Daily Percentage Leaders On N.Y. Stock Exchange
NEW YORK -- The following list shows the stocks that have gone
up the
most and down the most based on percent of change on the New
York Stock
Exchange regardless of volume for Thursday.
Net and percentage changes are the difference between the
previous
closing price and yesterday's last price.
UPS
Name Sales (hds) High Low Last Net Pct.
1 Welbilt Cp. . . . . 56 1 1/4 1 1 1/4 + 1/4 Up 25.0
2 Int T&T pfF . . . . 1 68 68 68 + 8 Up 13.3
3 IDS Rlty Tr. . . . 293 5 3/8 4 7/8 5 3/8 + 5/8 Up 13.2
4 Centrn Data . . . . 811 19 1/2 17 3/8 18 5/8 + 1 3/4 Up
10.4
5 Texfi Ind. . . . . 13 5 3/8 5 1/4 5 3/8 + 2 Up 10.3
6 Heler Int pf. . . . 2 121 1/4 121 1/4 121 1/4 +11 1/4 Up
10.2
7 CCI Corp. . . . . . 9 1 1/2 1 1/2 1 1/2 + 1/8 Up 9.1
8 Royal Ind. . . . . 150 4 7/8 4 1/2 4 5/8 + 3/8 Up 8.8
9 Readg Co. . . . . . 58 3 1/4 3 1/8 3 1/8 + 1/4 Up 8.7
10 Rockower. . . . . . 50 9 5/8 8 3/4 9 1/2 + 3/4 Up 8.6
DOWNS
Name Sales (hds) High Low Last Net Pct.
1 Falstaff. . . . . . 178 4 3 3/8 3 3/8 - 7/8 Off 20.6
2 Seab Cst Lin. . . . 2825 24 3/8 22 5/8 23 3/4 - 4 5/8 Off
16.3
3 Emp 4.75pf. . . . . z100 4 1/4 4 1/4 4 1/4 - 5/8 Off 12.8
4 Bulova Wat. . . . . 77 8 1/2 7 1/2 7 1/2 - 1 Off 11.8
5 Leh Val lnd. . . . 32 1 1/4 1 1/8 1 1/8 - 7/8 Off 10.0
6 Adams Drg. . . . . 116 3 7/8 3 1/2 3 1/2 - 3/8 Off 9.7
7 Benguet B. . . . . 226 2 3/4 2 1/2 2 1/2 - 1/4 Off 9.1
8 ChaseMTr. . . . . . 325 4 1/8 3 3/4 3 3/4 - 3/8 Off 9.1
9 Plan Resrch. . . . 212 4 3/8 3 7/8 3 7/8 - 3/8 Off 8.8
10 Xerox Cp. . . . . 3350 87 78 1/2 78 5/8 - 7 5/8 Off 8.8
ewm:
[
Footnote 2/1]
Unrealized appreciation is the difference between the cost basis
of a retained asset and its market or appraised value, where the
latter exceeds cost.
[
Footnote 2/2]
The cost basis for petitioner's Xerox securities for the 1966
tax year was some $14,000 less than for 1965, apparently reflecting
the payment as a dividend of 870 shares of Xerox stock in 1965. The
"appreciation" figures used herein come from Petitioner's Brief,
and vary somewhat from the figures used by the Government, but the
differences are insignificant in the context of this case. Rounded
figures are used throughout this opinion.
[
Footnote 2/3]
The Court refers to net liquidation value, which reflects the
asset's current market price less the costs and expenses attendant
to its liquidation. The Court thus seeks to identify the sum that
would be made available by a hypothetical sale of the asset in
question, although nothing in the statute requires such a
liquidation. For the purpose of discussion, I will refer simply to
market value or market price.
[
Footnote 2/4]
There may be some ambiguity in the critical language stating the
Court's theory of the case,
ante at
422 U. S. 626,
as to whether it intends the term "accumulated" to refer only to
earnings and profits accumulated in the tax year in question or to
all accumulated and undistributed earnings as shown by the
corporation's earned surplus account. I assume the Court refers to
the latter, as the statutory language and purpose contemplate
consideration of the total accumulation in determining whether the
retention of earnings and profits of a given year has been in
excess of the amount justified by reasonable business needs.
[
Footnote 2/5]
It is not unusual, of course, for a corporation also to show
parenthetically on its balance sheet, or in a footnote thereto, the
market price of assets when that figure can be ascertained readily.
But unrealized appreciated value, whether based on market price or
an appraisal of the asset, is normally not included in the sum of a
corporation's assets or in its surplus account on the liability
side of its balance sheet.
[
Footnote 2/6]
See 11 W. Fletcher, Cyclopedia of the Law of Private
Corporations §§ 5329, 5329.1, 5335, 5335.1 (1971). Some States have
statutes expressly prohibiting recognition of unrealized
appreciation as a source upon which a corporation can rely in
determining the amount of a dividend that legally can be paid.
E.g., Cal.Corp.Code §§ 1502, 1505 (1955); Ind.Ann.Stat. §
23-1-2-15(a) (1972). Other States have statutes allowing limited
recognition of unrealized appreciation.
E.g., Minn.Stat. §
301.22(1) (1974) (a corporation may take into account appreciation
of "securities having a readily ascertainable market value";
otherwise, unrealized appreciation may not be counted in computing
earnings available for dividends); Ohio Rev.Code Ann. § 1701.33(A)
(Supp. 1974) (allows only share dividends to be paid from
unrealized appreciation). The decisional law of States lacking
precise statutory guidance generally prohibits reliance on
unrealized appreciation. 11 W. Fletcher,
supra, § 5335.1;
H. Henn, Handbook of the Law of Corporations and Other Business
Enterprises § 320, pp. 652-653 (1970).
Georgia's law follows the Model Business Corporation Act,
allowing payment of cash or property dividends only out of earned
surplus or current earnings. Ga.Code Ann. § 22-511(a)(1) (1970);
Model Bus. Corp.Act § 45(a). Share dividends may be paid out of
capital surplus on certain conditions, Ga.Code Ann. § 22-511(a)(4);
Model Bus. Corp.Act § 45(d), and stricter conditions govern the
declaration of cash or property dividends out of capital surplus.
Ga.Code Ann. § 22-512; Model Bus. Corp.Act § 46. Commentators have
suggested that, under the Model Act, a corporation could revalue
its assets, creating capital surplus out of the unrealized
appreciation, and then pay dividends out of the capital surplus,
but that course of action is considered quite risky for the
directors. Bugge, Unrealized Appreciation as a Source of
Shareholder Distributions Under the Wisconsin Business Corporation
Law, 1964 Wis.L.Rev. 292, 300-304, 312-313; Hackney, The Financial
Provisions of the Model Business Corporation Act, 70 Harv.L.Rev.
1357, 1377-1381 (1957). Under Georgia law, Ga.Code Ann. § 22715(c),
as under the Model Act § 48, a director is not liable for an
illegal dividend distribution if, in computing the amount available
for dividends, he considers the corporate assets at their "book
value."
[
Footnote 2/7]
Among other things, the term "security" includes stocks, bonds,
debentures, certificates of interest or participation in
profit-sharing agreements, collateral trust certificates,
investment contracts, voting trust certificates, fractional
undivided interests in oil, gas, or other mineral rights, or "in
general, any interest or instrument commonly known as a
security. . . .'" 48 Stat. 74, as amended, 15 U.S.C. § 77b(1);
48 Stat. 882, as amended, 15 U.S.C. § 78c(10). See United
Housing Foundation, Inc. v. Forman, 421 U.
S. 837 (1975).
[
Footnote 2/8]
The following hypothetical example suggests the difficulty of
application of today's decision. If petitioner had invested the
same $147,000 of earnings in southern pine timberlands, and if by
the end of the tax years in question the unrealized appreciation in
value of these lands was precisely the same $1,475,000 and
$2,416,000, respectively, as was the appreciation of the Xerox
stock here at issue, would the Commissioner have been entitled to
take the unrealized appreciation into account? In many instances,
well situated timberlands have appreciated in value as much as or
more than most marketable securities. Such lands are not carried on
corporate balance sheets as current assets, and yet experience
indicates that growing timber and timberlands are often highly
marketable.
[
Footnote 2/9]
I hardly think that the Court's brandishment of the threat of
criminal liability for willful tax evasion through investment in a
particular type of asset,
see ante at
422 U. S. 630,
n. 11, will suffice to deter future investment decisions made with
the intention of avoiding the pitfalls of this decision. I cannot
agree with the Court's suggestion that this motivation would
convert an otherwise legitimate investment choice into a criminal
offense. Corporate management considers the potential tax
implications of countless business decisions, and might reasonably
be expected to assess the possible impact of a choice between
investing in nonliquid or liquid assets on its potential future
liability for the accumulated earnings tax.
"The fact that the incidences of income taxation may have been
taken into account by arranging matters one way rather than
another, so long as the way chosen was the way the law allows, does
not make a transaction something else than it truly is. . . ."
Commissioner v. Wodehouse, 337 U.
S. 369,
337 U. S. 410
(1949) (Frankfurter, J., dissenting). This is especially true where
questions of criminal liability are involved.
[
Footnote 2/10]
The following swings in the value of Xerox stock illustrate the
point: on May 16, 1975, the high was 87 and the low 78 1/2. If
petitioner continued to own 10,000 shares, its potentially
available source of funds would have shrunk by $85,000 in a single
day. In the month of August, 1974, Xerox varied in market price
from 98 to a low of 74 1/4, a 24.2% swing. Again, assuming a
holding of 10,000 shares, the owner would have suffered paper
"losses" in that one month of approximately $237,500, or about
one-fourth of market value. Considering the entire calendar year of
1965, Xerox sold as high as 71 and as low as 31, a variation on the
down side of 55.9% and on the up side of 120%. In dollars, a person
who bought 10,000 shares of Xerox in 1965 at its lowest and sold at
the highest price would have enjoyed a pretax profit of $400,000.
But in 1974, in which the high was 127 and the low 49, a taxpayer
whose Xerox stock was assessed on the day of the market's peak, and
who continued to own it, would find himself at the later date
having "lost" 61% of what this Court deems the "realistic" or
"true" value of the investment.
See 422
U.S. 617appa1|>Appendix A-1,
infra.
[
Footnote 2/11]
The wide gyrations in value of some of the equity securities
listed in the
422
U.S. 617appa1|>Appendices to this opinion illustrate the
point. For example, on May 16, 1975, the common stock of the
Falstaff Corp. fell 20.6% in a single day. The Court's opinion
assumes that corporate management should plan to satisfy future
business needs from the unrealized appreciation in value of such
securities at a given point in time. The instability of market
prices of common stocks suggests that this assumption is
unsound.
[
Footnote 2/12]
The basic facts of
National Grocery are not fully
revealed in this Court's opinion, but must be obtained from the
opinions of the Board of Tax Appeals, 35 B.T.A. 163 (1936), the
Court of Appeals for the Third Circuit, 92 F.2d 931 (1937), and the
briefs filed in this Court by the parties. In addition to those set
forth above, the following are relevant: the decline in market
value of the taxpayer's listed securities in the fiscal year
aggregated $943,500; the $2,000,000 shrinkage figure mentioned by
this Court included, in addition, the taxpayer's attempted
elimination of $1,068,000 cost value of bank stocks claimed to be
wholly unmarketable. Brief for Respondent in No. 723, O.T. 1937,
pp. 34-35. In addition, as appears from the opinion of the Court of
Appeals, National Grocery also claimed "that [its] merchandise
shrank in value well on to a quarter million dollars, and the real
estate declined in value $125,000." 92 F.2d at 933. All of this
alleged depreciation and shrinkage was claimed to have occurred in
the taxable year, and was sought to be offset against net earnings
for that year.