Bailey v. Railroad Company, 89 U.S. 604 (1874)
U.S. Supreme CourtBailey v. Railroad Company, 89 U.S. 22 Wall. 604 604 (1874)
Bailey v. Railroad Company
89 U.S. (22 Wall.) 604
1. In December, 1868, a railroad company, which was in existence in 1862 and before but which by its charter was limited to 10 percent dividends on its capital, now all taken, reciting that it had
"hitherto expended of its earnings for the purpose of constructing and equipping its road, and in the purchase of real estate and outer properties with a view to the increase of its traffic, moneys equal to 80 percent of its capital,"
and reciting farther that the stockholders were "entitled to evidence of such expenditure and to reimbursement of the same at some convenient future period," resolved to give them and did give them in proportion to the amount of stock held by them respectively, certificates which it called "interest certificates," which certified that A. B. "being the holder of ___ shares of the capital stock of the company, was entitled to $___, payable ratably with the other like certificates, at the pleasure of the company out of its future earnings, with dividends thereon at the same rates and times as dividends should he paid upon the capital stock of the company." The "certificate" was declared to be transferable on the books of the company, and had a transfer in blank at the foot of it, in the form common at the foot of certificates of stock, with an appointment in blank of an attorney to transfer.
Held that this was a "dividend in scrip," within the twenty-second section of the Internal Revenue Act of June 30, 1864, its subsequently amended, which enacts that
"any railroad company which may have declared any dividend in scrip or money due or payable to its stockholders as part of the earnings, profits, income, or gains of such company, carried to the account of any fund, or used for construction, shall be subject to and pay a tax of five percentum on the amount of such
dividends or profits, whenever and wherever the name shall be payable,"
and which authorized the company making such dividend to withhold the five percent tax.
2. The said company having declared, in February and August, 1869, two dividends on these certificates, as well as on its stock, and having paid a tax of 5 percent on all the dividends, without any suggestion by the revenue officers that any further tax was due, became, in February, 1870, under legislative authority, consolidated with another company; the statute under which the consolidation was effected enacting that it should be lawful for the old company "to merge and consolidate its capital stock, franchises, and property" with the other company which it was proposed to become united with, but enacting also
"that the rights of all creditors of and all liens open the property of either of said corporations shall be preserved unimpaired, and the respective corporations shall be deemed to continue in existence to preserve the same, and that all debts and liabilities incurred by either of said corporations (except mortgages) shall thenceforth attach to such new corporation and be enforced against it."
Held that the new company was liable to the five percent tax on the dividend in scrip, which the old one was bound to pay. And the new company having paid it under protest, to save its property from being sold on a levy for it; held further, on assumpsit brought by the new company against the collector to recover back the money, that the dividend in scrip having been decided to be a proper subject for the five percent tax, and the company -- notwithstanding a violation of its own duty in making, without demand, a return of the dividend -- having had, in fact, a full hearing before the officers of internal revenue and obtained thereby a large abatement from the tax as originally assessed, this Court would not suffer a recovery by the railroad company against the collector, because, in compelling payment of the tax, he had not conformed with certain proceedings of form intended to secure a full hearing to taxpayers, which the act made it lawful and perhaps proper for the assessor to do before resorting to the ulterior measure of levy on the company's property.
3. On a question whether the so-called "interest certificates" were taxable as a dividend in scrip, evidence from the reports, both of the old and of the new company, was allowable to show that from the time the "interest certificates" were issued up to the time of the suit, dividends were declared and paid on them just as on the company's capital stock.
The 22d section of the Internal Revenue Act of June 30, 1864, [Footnote 1] enacts:
"That any railroad company that may have declared any dividend in scrip or money due or payable to its stockholders as part of the earnings, profits, income, or gains of such company carried to the account of any fund or used for construction shall be subject to and pay a tax of 5 percentum on the amount of all such dividends or profits, whenever and wherever the same shall be payable; and said companies are hereby authorized to deduct and withhold from all payments on account of any dividends, due and payable, as aforesaid, the tax of 5 percentum."
"And a list or return shall be made and rendered to the assessor on or before the 10th of the month following that in which said dividends became due and payable and as often as every six months, and said list or return shall contain a true and faithful account of the amount of tax, and there shall be annexed thereunto a declaration of the president or treasurer of the company, under oath or affirmation, that the same contains a true and faithful account of said tax."
"And for any default in making or rendering such list or return or in the payment of the tax aforesaid, the company making such default shall forfeit as a penalty the sum of $1,000."
The fourteenth section of the act thus enacts: [Footnote 2]
"If any person shall not deliver a monthly or other list or return by the time required by law, or if any person shall deliver or disclose to any assessor or assistant assessor any list, statement, or return, which in the opinion of the assessor is false or fraudulent or containing any understatement or undervaluation, it shall be lawful for the assessor to summon such person, his agent, or other person having possession, custody, or care of books of account containing entries relating to such person, to appear before such assessor, produce such books at any time or place therein named, to give testimony, to answer interrogations under oath or affirmation respecting any objects liable to tax as aforesaid on the lists, statements, or returns thereof on any trade, business, or profession liable to any tax as aforesaid, and the assessor may summon as aforesaid any person residing or found within the state in which his district is situated, and when the person intended to be summoned
does not reside and cannot be found within the state, then the assessor may enter any collection district where such person may be found and there make the examination, hereinbefore authorized, and to this end he shall have and may exercise all the power and authority he has or may lawfully exercise in the district to which he is commissioned. . . . It shall be the duty of the assessor or assistant assessor of the district within which such person may have taxable property to enter into and upon the premises, if it be necessary, of such person so refusing or neglecting or rendering a false or fraudulent return and to make, according to the best information he can obtain, including that derived from the evidence elicited by the examination by the assessor, and on his own view and information, such list or return, according to the form prescribed, of the property, goods, merchandise, wares, and all articles or objects liable to tax owned or possessed or under the care or management of such person and assess the tax thereon, including the amount, if any, due for special or income tax. . . . And the list or return so made and subscribed by said assessor or assistant assessor shall be taken and reputed as good and sufficient for all legal purposes."
Section nineteen of the same statute enacts: [Footnote 3]
"That the assessor . . . shall give notice by advertisement in one newspaper published in each county and shall post notices &c. stating the time and place where appeals shall be received and determined, relative to any erroneous or excessive valuation. . . . And such assessor is hereby authorized at any time to hear and determine in a summary way, according to law and right, upon any and all appeals by parties who shall appear voluntarily before him, &c. And shall have power to reexamine and determine upon the assessments and valuations, and rectify the same as shall appear just and equitable."
On the 19th of December, 1868 -- the above-quoted enactment being then in force -- the New York Central Railroad -- a company having its road between Albany and Buffalo and which had been in existence since 1853 -- passed resolutions authorizing the issue of certain certificates to the stockholders of the company to the amount of 80 percent
of the amount of the capital stock of the company. The company by its charter was restricted to annual dividends of 10 percent. The certificates were named "interest certificates," and the aggregate amount of them authorized by the said resolutions was $23,036,000. The amount of the capital stock of the company, at the time said resolutions were passed, was $28,795,000, and it was at this time all taken. The resolutions and certificate referred to each other, and all together made the form of the certificate. The following is a copy of the resolutions and certificate:
"THE NEW YORK CENTRAL RAILROAD COMPANY"
"Whereas this company has hitherto expended of its earnings, for the purpose of constructing and equipping its road and in the purchase of real estate and other properties with a view to the increase of its traffic, moneys equal in amount to 80 percent of the capital stock of the company, and whereas the several stockholders of the company are entitled to evidence of such expenditure and to reimbursement of the same at some convenient future period, now, therefore,"
"Resolved that a certificate signed by the president and treasurer of this company be issued to the stockholders severally, declaring that such stockholder is entitled to 80 percent of the amount of the capital stock held by him, payable ratably with the other certificates issued under this resolution, at the option of the company, out of its future earnings, with dividends thereon, at the same rates and times as dividends shall be paid on shares of the capital stock of the company, and that such certificates may be, at the option of the company, convertible into stock of the company, whenever the company shall be authorized to increase its capital stock to an amount sufficient for such conversion."
The certificates were in this form:
"THE NEW YORK CENTRAL RAILROAD COMPANY"
"No. Interest Certificate"
Under a resolution of the board of directors of this company passed December 19, 1868, of which the above is a copy, the New York Central Railroad Company hereby certifies that A.B., being the holder of ____ shares of the capital stock of said company, is entitled to ____ dollars payable ratably with
the other certificates issued under said resolution at the pleasure of the company out of its future earnings, with dividends thereon, at the same rates and times as dividends shall be paid upon the shares of the capital stock of said company.
"This certificate may be transferred on the books of the company on the surrender of this certificate."
"In witness whereof, the said company has caused this certificate to be signed by its president and treasurer, this 19th day of December, 1868."
At the foot of each certificate there was a form of transfer in blank:
"For a valuable consideration, I, A.B., do hereby sell, assign, and transfer all interest in the above certificate to C.D., and do hereby irrevocably appoint E.F. attorney to execute a transfer thereof on the books of the railroad company therein mentioned."
The company declared two dividends of $921,440 each upon these interest certificates, payable respectively, February 20 and August 20, 1869, which were duly returned to the United States assessor, who assessed a tax of $46,072 upon each of them, which tax the company paid. The company also declared two dividends of $1,151,800 each upon its capital stock, payable, respectively, February 20 and August 20, 1869, which were also duly returned to the United States assessor, who assessed a tax of $57,590 upon each of them, which tax also the company paid. At the times these dividends upon the interest certificates and upon the stock were returned to the United States assessor, no allegation was made by the officers of the government that the returns of the said dividends were false or that as to them there was "any understatement or undervaluation" or that there had been any neglect on the part of the company to make a return as to the issue of said interest certificates, or that the said returns should have included the
interest certificates themselves as well as the dividends upon them.
At the time when these certificates were issued and taxes were paid, as for some years before, there existed in the State of New York a railroad company known as the Hudson River Railroad Company, a company having a road running from the City of New York to East Albany and there connecting by ferry with the road of the New York Central Railroad Company, just above mentioned, the two making a line of transit from the City of New York to Buffalo.
On the 1st of November, 1869, somewhat less than a year after the 80 percent "dividend of scrip" above mentioned was made by the New York Central Company, the two roads were consolidated under a general act of the Legislature of New York into a new company by the name of "The New York Central & Hudson River Railroad Company."
The act under which the consolidation was made enacts that it shall be lawful for any railroad company "to merge and consolidate its capital stock, franchises, and property with the capital stock, franchises, and property of any other company."
The fifth section of the act provided that:
"The rights of all creditors of, and all liens upon, the property of either of said corporations, parties to said agreement and act, shall be preserved unimpaired, and the respective corporations shall be deemed to continue in existence to preserve the same, and all debts and liabilities incurred by either of said corporations, except mortgages, shall thenceforth attach to such new corporation and be enforced against it and its property to the same extent as if said debts or liabilities had been incurred or contracted by it."
On the 26th of February, 1870, fourteen months after the certificates were authorized and nearly four months after the consolidation of the New York Central Railroad Company with the Hudson River Railroad Company, the United States assessor sent a notice, directed to "Charles Wendell,
Esq., Acting Treasurer, New York Central Railroad Company," and dated:
"ASSESSOR'S OFFICE, FOURTEENTH DISTRICT, N.Y."
"ALBANY, February 26th, 1870"
"SIR: I am directed by the Commissioner of Internal Revenue &c. to cause an assessment of taxes against the New York Central Railroad Company upon the scrip dividend, issued by resolution of the board of directors of said company, December 19, 1868."
"I am also requested to furnish the supervisor the names of persons to whom such scrip was issued. Will you please furnish me with the amount of such dividend and the names of the persons to whom the scrip was issued?"
"R. P. LATHROP"
"CHARLES WENDELL, ESQ.,"
"Acting Treasurer of the New York Central Railroad Company"
The assessor received no answer from Mr. Wendell nor from the New York Central Railroad Company in reply to the foregoing notice.
On the 3d of March, 1870, more than four months after the consolidation, and more considerably than a year after the "dividend" above mentioned had been made, the Assessor of Internal Revenue for the District of Albany, where the New York Central Railroad Company had had its principal office, made what he called and asserted to be an "assessment" against that company. The document ran thus:
"UNITED STATES INTERNAL REVENUE"
"Assessment against the New York Central Railroad Company"
"The New York Central Railroad Company having failed to make return of the scrip dividend, or interest certificates, voted at a meeting of the directors of said company held December 19, 1868, as required to do by section 122, Act June 30th, 1864, Act July 13, 1866, internal revenue laws."
"Now, therefore, by the authority vested in me and as required by the several sections of said internal revenue laws, I
do assess against the president, directors, and company of the New York Central Railroad the following tax, to-wit:"
Capital stock, December 19th, 1868 . . . . $28,795,000.00
Scrip dividend, or interest certificates,
being 80 percent of said capital . . . . 23,036,000.00
Tax on same at 5 percent . . . . . . . . . $ 1,151,800.00
Penalty for failure. . . . . . . . . . . . 1,000.00
Amount of tax . . . . . . . . . . . . . $1,152,800.00
"R. P. LATHROP, Assessor, Fourteenth District, N.Y."
"ALBANY, March 3, 1870"
This assessment was made on the day it bore date by the assessor alone in his office. He made no examination of the books or officers of the company for the purpose of ascertaining whether the certificates were one of the objects liable to tax under the internal revenue law, nor gave notice when an appeal from the assessment could be heard, nor did any other of the things of form prescribed by the above-quoted fourteenth and nineteenth sections of the Revenue Act, as things lawful to be done &c., in cases where the party liable to the tax had neglected or refused to make a return. He ascertained the amount of the scrip dividend from a document rendered by the company to the legislature of the state.
On an appeal made in February, 1872, from this assessment to the Commissioner of Internal Revenue, that officer held that the company was liable to a tax of 5 percent without penalty, on $9,214,400, being six-fifteenths of the entire dividend, the proportionate amount chargeable to the period between September 30, 1862, and September 30, 1868. This reduced the assessment to $460,720. And he directed that on payment of that sum the remainder of the assessment, viz., $692,080, including the $100 penalty, should be abated.
The assessment was accordingly reformed, but the New York Central and Hudson River Railroad Company still declined to pay it. The matter being referred by the revenue
bureau to its solicitor, this officer gave it as his opinion that the certificates were not taxable at all. It was afterwards submitted to Mr. Orton, former Commissioner of Internal Revenue, Mr. Smyth, former supervisor of the same, and to the assessor who, under direction, had made the assessment, and these officers concurred in opinion with the solicitor. For the sake of having the matter judicially decided, the collector thereupon, under three different warrants, reciting that "The New York Central Railroad Company, OR the New York Central and Hudson River Railroad Company" had become liable to the tax, seized a large number of the last-named company's locomotives and cars, and was proceeding to sell them when the amount claimed was paid under protest. The company now sued the collector in assumpsit to get back the money.
In the course of the trial, the counsel of the collector offered to read from the reports of the New York Central Railroad Company for the year 1869 and from the reports from the New York Central and Hudson River Railroad for the years 1870, 1871, and 1872 for the purpose of showing that the interest certificates were merged in the capital stock of the defendant in error in 1872 and that dividends were declared and paid on such interest certificates in 1869, 1870, and 1871, the same as upon the capital stock.
The counsel for the latter company, the plaintiff, objected to the evidence as incompetent and irrelevant, upon the ground that it was immaterial what was done with the certificates after they were issued; that the question was whether they were taxable by their character and in the circumstances existing at the time they were issued.
The court sustained the objection; the counsel for the collector excepting.
The case being closed, the court charged:
"Dividends are included as a well known indicia of the income of corporations, and constitute the profits divided by them after paying the expenses of their business and operations. They are usually declared in money, but as they are sometimes declared in stock, and known as scrip dividends, and as when
so declared they represent income as profits which are apportioned to stockholders in stock instead of in money, Congress, intending to reach income in every form, subjected to tax 'dividends in scrip or money.' The inquiry then is were the interest certificates, as issued by the company, a stock dividend? If they conferred on the respective stockholders any greater interest in the earnings or capital of the corporation than they had before receiving them, then they were a stock dividend though called 'interest certificates.' If they did not, they are not a stock dividend. Congress did not intend to tax dividends in stock which were not so in fact, and did not seek, while in search of income, to subject to tax that which is not income. In other words, they do not intend to tax, as stock dividends, those myths which, in the process known as watering stock, are sometimes assigned to shareholders of corporations as stock dividends. This intent is apparent from the limitation expressed. The tax is imposed on dividends declared in scrip or money, 'due as part of the earnings, profit, income, or gains of such company.' The certificates issued by the New York Central Railroad Company were issued as representing earnings and profits accruing from the operations of the company, and to that extent meet the requisites of a stock dividend. But did they vest in its stockholders any greater interest in its earnings or capital than they had prior thereto?"
"In my judgment, they did not. By the certificates and resolutions, the stockholders are entitled severally to 80 percent more of the stock than they had before, 'at the option of the company.' In other words, each stockholder shall have additional stock to that amount if the company shall, in its discretion and at its pleasure, see fit to assign it to him."
"The directors of the company reserve the right to decline, at their volition or caprice, to assign any additional stock. The stockholder receives nothing by the declaration of the resolutions and certificates but the naked assurance of a possibility which, at some indefinite future period, may result to his advantage. It is in no sense a vested right capable of enforcement, for he never could compel the company to transfer to him additional stock. It is true that the resolutions and certificates entitle the stockholder to a dividend to be paid on the 80 percent 'at the same time and ratably with dividends on the capital stock.' But I fail to see how this in any manner inures to his
advantage. The earnings of the company, instead of being applied to dividends on his capital stock, are applied on that and the certificates ratably, and to the extent that he receives a dividend on the certificates, his dividend on the capital stock is reduced. The stockholder derives and the company appropriates no income by the transaction which would not have been derived and appropriated if the certificates had never been issued. Another feature of the certificates is an important one as marking a wide difference between their legal effects and that of a certificate of stock. The 80 percent is not to be paid out of the general assets and earnings of the corporation; neither are the dividends which are thereafter to be made. The dividends to be declared upon the certificates are only to be paid out of the future earnings of the company. Upon a dissolution of the corporation, these certificate-holders would receive no part of the assets except those accumulated from the earnings after the certificates were issued. An assignment of all dividends thereafter to arise upon stock may in law amount to a transfer of the stock, because it would entitle the assignee to receive all the original stockholder could have obtained of the assets of the corporation. But a holder of these certificates would have no such right, and would not stand at all in the position of a stockholder towards the corporation in case of a dissolution."
"It is not asserted that these certificates give to the holder the right to vote, and here again, in an important feature, these certificates fail to vest the holder with the rights of a stockholder."
"Tested by all the rules by which we are to determine whether these certificates were certificates of stock, and as such entitle the holder to the rights of a stockholder in the corporation, the result is adverse to a conclusion in the affirmative. The tax was intended to be imposed upon gains and profits actually appropriated by the company and derived by the stockholders."
"The section which imposed it authorizes the company to deduct or withhold from all payments on account of any dividend due and payable as aforesaid the tax of 5 percent from the stockholder to whom the same is payable. Can it be seriously asserted that if the New York Central Railroad Company had withheld 5 percent of the 80 percent from the amount of its dividend next declared after it issued these certificates, and deducted that sum from the dividends due to a stockholder, the
company would have been protected? The stockholder would have insisted that he had received no additional income by reason of the certificates, and it was not intended by the law to tax him through the corporation for that for which he could not be taxed personally."
"Or suppose, again, the assessor had attempted to compel the stockholder to pay a 5 percent tax on a sum equivalent to 80 percent of his stock in the company on the ground that the company had not deducted the tax from his dividend -- would it not be revolting to common sense to insist that he should pay these certificates as income actually received by him, when he had not only received no income in fact, but had not received that from which he could enforce or derive income in the future by any legal remedy?"
"If the certificates did not represent income received by the stockholders, they were not of the character which the law intended to reach, because the dividends subjected to the tax were only those from which, by the act, the corporation could deduct the 5 percent imposed on the income of a stockholder, derived by him in the form of a dividend."
"My conclusion is that the tax was erroneously assessed, and the defendant must pay the amount realized by his proceedings."
"Had the tax been assessed upon the 'profits of such company, carried to the account of any fund, or used for construction,' it might have been enforced for the amount actually carried to the fund or used for construction since 1862, when the Internal Revenue Act was adopted."
The court thereupon directed the jury to render a verdict for the plaintiff for the sum of $594,002.89, which the jury did, and judgment being entered accordingly, the collector brought the case here, assigning for error:
1. The action of the court below, on the trial, excluding the report of the New York Central Railroad Company, and the reports of the plaintiff, offered by the defendant for the purpose of showing that the interest certificates were merged in the capital stock of such plaintiff in the year 1872 &c.
2. The instruction of the court that the action of the New York Central Railroad Company, as evidenced by the resolution
and certificates issued December 19, 1868, was not a declaration of a dividend in scrip within the meaning of the United States Internal Revenue Act then in force.
3. The direction given to the jury to render a verdict for the plaintiff for $594,002.89, and the judgment given therefor.