U.S. Supreme Court Eisner v. Macomber, 252 U.S. 189 (1920) Eisner v. Macomber No.

318 Argued April 16, 1919 Restored to docket for reargument May 19, 1919 Reargued October 17, 20, 1919 Decided March 8, 1920 252 U.S. 189 ERROR TO THE DISTRICT COURT OF THE UNITED STATES FOR THE SOUTHERN DISTRICT OF NEW YORK Syllabus Congress was not empowered by the Sixteenth Amendment to tax, as income of the stockholder, without apportionment, a stock dividend made lawfully and in good faith against profits accumulated by the corporation since March 1, 1913. P. 252 U. S. 201.Towne v. Eisner, 245 U. S. 418. The Revenue Act of September 8, 1916, c. 463, 39 Stat. 756, plainly evinces the purpose of Congress to impose such taxes, and is to that extent in conflict with Art. I, 2, cl. 3, and Art. I, 9, cl. 4, of the Constitution. Pp. 252 U. S. 199, 252 U. S. 217. These provisions of the Constitution necessarily limit the extension, by construction, of the Sixteenth Amendment. P. 252 U. S. 205. What is or is not "income" within the meaning of the

Amendment must be determined in each case according to truth and substance, without regard to form. P. 252 U. S. 206. Income may be defined as the gain derived from capital, from labor, or from both combined, including profit gained through sale or conversion of capital. P. 252 U. S. 207. Mere growth or increment of value in a capital investment is not income; income is essentially a gain or profit, in itself, of exchangeable value, proceeding from capital, severed from it, and derived or received by the taxpayer for his separate use, benefit, and disposal. Id. A stock dividend, evincing merely a transfer of an accumulated surplus to the capital account of the corporation, takes nothing from the property of the corporation and adds nothing to that of the shareholder; a tax on such dividends is a tax an capital increase, and not on income, and, to be valid under the Constitution, such taxes must be apportioned according to population in the several states. P. 252 U. S. 208. Affirmed. Page 252 U. S. 190 The case is stated in the opinion. Page 252 U. S. 199 MR. JUSTICE PITNEY delivered the opinion of the Court. This case presents the question whether, by virtue of the Sixteenth Amendment, Congress has the power to tax, as income of the stockholder and without apportionment, a stock dividend made lawfully and in good faith against profits accumulated by the corporation since March 1, 1913. It arises under the Revenue Act of September 8, 1916, 39 Stat. 756 et seq., which, in our opinion (notwithstanding a

contention of the government that will be Page 252 U. S. 200 noticed), plainly evinces the purpose of Congress to tax stock dividends as income. * The facts, in outline, are as follows: On January 1, 1916, the Standard Oil Company of California, a corporation of that state, out of an authorized capital stock of $100,000,000, had shares of stock outstanding, par value $100 each, amounting in round figures to $50,000,000. In addition, it had surplus and undivided profits invested in plant, property, and business and required for the purposes of the corporation, amounting to about $45,000,000, of which about $20,000,000 had been earned prior to March 1, 1913, the balance thereafter. In January, 1916, in order to readjust the capitalization, the board of directors decided to issue additional shares sufficient to constitute a stock dividend of 50 percent of the outstanding stock, and to transfer from surplus account to capital stock account an amount equivalent to such issue. Appropriate resolutions were adopted, an amount equivalent to the par value of the proposed new stock was transferred accordingly, and the new stock duly issued against it and divided among the stockholders. Defendant in error, being the owner of 2,200 shares of the old stock, received certificates for 1, 100 additional Page 252 U. S. 201 shares, of which 18.07 percent, or 198.77 shares, par value $19,877, were treated as representing surplus earned between March 1, 1913, and January 1, 1916. She was called upon to pay, and did pay under protest, a tax imposed under the Revenue Act of 1916, based upon a supposed income of

$19,877 because of the new shares, and, an appeal to the Commissioner of Internal Revenue having been disallowed, she brought action against the Collector to recover the tax. In her complaint, she alleged the above facts and contended that, in imposing such a tax the Revenue Act of 1916 violated article 1, 2, cl. 3, and Article I, 9, cl. 4, of the Constitution of the United States, requiring direct taxes to be apportioned according to population, and that the stock dividend was not income within the meaning of the Sixteenth Amendment. A general demurrer to the complaint was overruled upon the authority of Towne v. Eisner, 245 U. S. 418, and, defendant having failed to plead further, final judgment went against him. To review it, the present writ of error is prosecuted. The case was argued at the last term, and reargued at the present term, both orally and by additional briefs. We are constrained to hold that the judgment of the district court must be affirmed, first, because the question at issue is controlled by Towne v. Eisner, supra; secondly, because a reexamination of the question with the additional light thrown upon it by elaborate arguments has confirmed the view that the underlying ground of that decision is sound, that it disposes of the question here presented, and that other fundamental considerations lead to the same result. In Towne v. Eisner, the question was whether a stock dividend made in 1914 against surplus earned prior to January 1, 1913, was taxable against the stockholder under the Act of October 3, 1913, c. 16, 38 Stat. 114, 166, which provided ( B, p. 167) that net income should include "dividends," and also "gains or profits and income derived Page 252 U. S. 202 from any source whatever." Suit having been brought by a

stockholder to recover the tax assessed against him by reason of the dividend, the district court sustained a demurrer to the complaint. 242 F. 702. The court treated the construction of the act as inseparable from the interpretation of the Sixteenth Amendment; and, having referred to Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, and quoted the Amendment, proceeded very properly to say (p. 704): "It is manifest that the stock dividend in question cannot be reached by the Income Tax Act and could not, even though Congress expressly declared it to be taxable as income, unless it is in fact income." It declined, however, to accede to the contention that, in Gibbons v. Mahon, 136 U. S. 549, "stock dividends" had received a definition sufficiently clear to be controlling, treated the language of this Court in that case as obiter dictum in respect of the matter then before it (p. 706), and examined the question as res nova, with the result stated. When the case came here, after overruling a motion to dismiss made by the government upon the ground that the only question involved was the construction of the statute, and not its constitutionality, we dealt upon the merits with the question of construction only, but disposed of it upon consideration of the essential nature of a stock dividend disregarding the fact that the one in question was based upon surplus earnings that accrued before the Sixteenth Amendment took effect. Not only so, but we rejected the reasoning of the district court, saying (245 U.S. 245 U. S. 426): "Notwithstanding the thoughtful discussion that the case received below we cannot doubt that the dividend was capital as well for the purposes of the Income Tax Law as for distribution between tenant for life and remainderman. What was said by this Court upon the latter question is equally true

for the former." "A stock dividend really takes nothing from the property of the corporation, and adds nothing to the Page 252 U. S. 203 interests of the shareholders. Its property is not diminished, and their interests are not increased. . . . The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones." "Gibbons v. Mahon, 136 U. S. 549, 136 U. S. 559-560. In short, the corporation is no poorer and the stockholder is no richer than they were before. Logan County v. United States, 169 U. S. 255, 169 U. S. 261. If the plaintiff gained any small advantage by the change, it certainly was not an advantage of $417,450, the sum upon which he was taxed. . . . What has happened is that the plaintiff's old certificates have been split up in effect and have diminished in value to the extent of the value of the new." This language aptly answered not only the reasoning of the district court, but the argument of the Solicitor General in this Court, which discussed the essential nature of a stock dividend. And if, for the reasons thus expressed, such a dividend is not to be regarded as "income" or "dividends" within the meaning of the Act of 1913, we are unable to see how it can be brought within the meaning of "incomes" in the Sixteenth Amendment, it being very clear that Congress intended in that act to exert its power to the extent permitted by the amendment. In Towne v. Eisner, it was not contended that any construction of the statute could make it narrower

than the constitutional grant; rather the contrary. The fact that the dividend was charged against profits earned before the Act of 1913 took effect, even before the amendment was adopted, was neither relied upon nor alluded to in our consideration of the merits in that case. Not only so, but had we considered that a stock dividend constituted income in any true sense, it would have been held taxable under the Act of 1913 notwithstanding it was Page 252 U. S. 204 based upon profits earned before the amendment. We ruled at the same term, in Lynch v. Hornby, 247 U. S. 339, that a cash dividend extraordinary in amount, and in Peabody v. Eisner, 247 U. S. 347, that a dividend paid in stock of another company, were taxable as income although based upon earnings that accrued before adoption of the amendment. In the former case, concerning "corporate profits that accumulated before the act took effect," we declared (pp. 247 U. S. 343-344): "Just as we deem the legislative intent manifest to tax the stockholder with respect to such accumulations only if and when, and to the extent that, his interest in them comes to fruition as income, that is, in dividends declared, so we can perceive no constitutional obstacle that stands in the way of carrying out this intent when dividends are declared out of a preexisting surplus. . . . Congress was at liberty under the amendment to tax as income, without apportionment, everything that became income, in the ordinary sense of the word, after the adoption of the amendment, including dividends received in the ordinary course by a stockholder from a corporation, even though they were extraordinary in amount and might appear upon analysis to be a mere realization in possession of an inchoate and contingent

interest that the stockholder had in a surplus of corporate assets previously existing." In Peabody v. Eisner, 247 U. S. 349, 247 U. S. 350, we observed that the decision of the district court in Towne v. Eisner had been reversed "only upon the ground that it related to a stock dividend which in fact took nothing from the property of the corporation and added nothing to the interest of the shareholder, but merely changed the evidence which represented that interest," and we distinguished the Peabody case from the Towne case upon the ground that "the dividend of Baltimore & Ohio shares was not a stock dividend but a distribution in specie of a portion of the assets of the Union Pacific." Therefore, Towne v. Eisner cannot be regarded as turning Page 252 U. S. 205 upon the point that the surplus accrued to the company before the act took effect and before adoption of the amendment. And what we have quoted from the opinion in that case cannot be regarded as obiter dictum, it having furnished the entire basis for the conclusion reached. We adhere to the view then expressed, and might rest the present case there not because that case in terms decided the constitutional question, for it did not, but because the conclusion there reached as to the essential nature of a stock dividend necessarily prevents its being regarded as income in any true sense. Nevertheless, in view of the importance of the matter, and the fact that Congress in the Revenue Act of 1916 declared (39 Stat. 757) that a "stock dividend shall be considered income, to the amount of its cash value," we will deal at length with the constitutional question, incidentally testing the soundness of

our previous conclusion. The Sixteenth Amendment must be construed in connection with the taxing clauses of the original Constitution and the effect attributed to them before the amendment was adopted. In Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, under the Act of August 27, 1894, c. 349, 27, 28 Stat. 509, 553, it was held that taxes upon rents and profits of real estate and upon returns from investments of personal property were in effect direct taxes upon the property from which such income arose, imposed by reason of ownership, and that Congress could not impose such taxes without apportioning them among the states according to population, as required by Article I, 2, cl. 3, and 9, cl. 4, of the original Constitution. Afterwards, and evidently in recognition of the limitation upon the taxing power of Congress thus determined, the Sixteenth Amendment was adopted, in words lucidly expressing the object to be accomplished: "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among Page 252 U. S. 206 the several states and without regard to any census or enumeration." As repeatedly held, this did not extend the taxing power to new subjects, but merely removed the necessity which otherwise might exist for an apportionment among the states of taxes laid on income. Brushaber v. Union Pacific R. Co., 240 U. S. 1, 240 U. S. 17-19; Stanton v. Baltic Mining Co., 240 U. S. 103, 240 U. S. 112 et seq.; Peck & Co. v. Lowe, 247 U. S. 165, 247 U. S. 172-173.

A proper regard for its genesis, as well as its very clear language, requires also that this amendment shall not be extended by loose construction, so as to repeal or modify, except as applied to income, those provisions of the Constitution that require an apportionment according to population for direct taxes upon property, real and personal. This limitation still has an appropriate and important function, and is not to be overridden by Congress or disregarded by the courts. In order, therefore, that the clauses cited from Article I of the Constitution may have proper force and effect, save only as modified by the amendment, and that the latter also may have proper effect, it becomes essential to distinguish between what is and what is not "income," as the term is there used, and to apply the distinction, as cases arise, according to truth and substance, without regard to form. Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate, and within whose limitations alone that power can be lawfully exercised. The fundamental relation of "capital" to "income" has been much discussed by economists, the former being likened to the tree or the land, the latter to the fruit or the crop; the former depicted as a reservoir supplied from springs, the latter as the outlet stream, to be measured by its flow during a period of time. For the present purpose, we require only a clear definition of the term "income," Page 252 U. S. 207 as used in common speech, in order to determine its meaning in the amendment, and, having formed also a correct judgment as to the nature of a stock dividend, we shall find it easy to decide the matter at issue.

After examining dictionaries in common use (Bouv. L.D.; Standard Dict.; Webster's Internat. Dict.; Century Dict.), we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909 (Stratton's Independence v. Howbert, 231 U. S. 399, 231 U. S. 415; Doyle v. Mitchell Bros. Co., 247 U. S. 179, 247 U. S. 185), "Income may be defined as the gain derived from capital, from labor, or from both combined," provided it be understood to include profit gained through a sale or conversion of capital assets, to which it was applied in the Doyle case, pp. 247 U. S. 183-185. Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word "gain," which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. "Derived from capital;" "the gain derived from capital," etc. Here, we have the essential matter: not a gainaccruing to capital; not a growth or increment of value in the investment; but a gain, a profit, something of exchangeable value, proceeding from the property, severed fromthe capital, however invested or employed, and coming in, being "derived" -that is,received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal -- that is income derived from property. Nothing else answers the description. The same fundamental conception is clearly set forth in the Sixteenth Amendment -- "incomes, from whatever source derived" -- the essential thought being expressed Page 252 U. S. 208 with a conciseness and lucidity entirely in harmony with the

form and style of the Constitution. Can a stock dividend, considering its essential character, be brought within the definition? To answer this, regard must be had to the nature of a corporation and the stockholder's relation to it. We refer, of course, to a corporation such as the one in the case at bar, organized for profit, and having a capital stock divided into shares to which a nominal or par value is attributed. Certainly the interest of the stockholder is a capital interest, and his certificates of stock are but the evidence of it. They state the number of shares to which he is entitled and indicate their par value and how the stock may be transferred. They show that he or his assignors, immediate or remote, have contributed capital to the enterprise, that he is entitled to a corresponding interest proportionate to the whole, entitled to have the property and business of the company devoted during the corporate existence to attainment of the common objects, entitled to vote at stockholders' meetings, to receive dividends out of the corporation's profits if and when declared, and, in the event of liquidation, to receive a proportionate share of the net assets, if any, remaining after paying creditors. Short of liquidation, or until dividend declared, he has no right to withdraw any part of either capital or profits from the common enterprise; on the contrary, his interest pertains not to any part, divisible or indivisible, but to the entire assets, business, and affairs of the company. Nor is it the interest of an owner in the assets themselves, since the corporation has full title, legal and equitable, to the whole. The stockholder has the right to have the assets employed in the enterprise, with the incidental rights mentioned; but, as stockholder, he has no right to withdraw, only the right to persist, subject to the risks of the enterprise, and looking only to dividends for his return. If he desires to dissociate himself

Page 252 U. S. 209 from the company, he can do so only by disposing of his stock. For bookkeeping purposes, the company acknowledges a liability in form to the stockholders equivalent to the aggregate par value of their stock, evidenced by a "capital stock account." If profits have been made and not divided, they create additional bookkeeping liabilities under the head of "profit and loss," "undivided profits," "surplus account," or the like. None of these, however, gives to the stockholders as a body, much less to any one of them, either a claim against the going concern for any particular sum of money or a right to any particular portion of the assets or any share in them unless or until the directors conclude that dividends shall be made and a part of the company's assets segregated from the common fund for the purpose. The dividend normally is payable in money, under exceptional circumstances in some other divisible property, and when so paid, then only (excluding, of course, a possible advantageous sale of his stock or windingup of the company) does the stockholder realize a profit or gain which becomes his separate property, and thus derive income from the capital that he or his predecessor has invested. In the present case, the corporation had surplus and undivided profits invested in plant, property, and business, and required for the purposes of the corporation, amounting to about $45,000,000, in addition to outstanding capital stock of $50,000,000. In this, the case is not extraordinary. The profits of a corporation, as they appear upon the balance sheet at the end of the year, need not be in the form of money on hand in excess of what is required to meet current liabilities and finance current operations of the company. Often, especially in a growing business, only a part, sometimes a small part, of the

year's profits is in property capable of division, the remainder having been absorbed in the acquisition of increased plant, Page 252 U. S. 210 equipment, stock in trade, or accounts receivable, or in decrease of outstanding liabilities. When only a part is available for dividends, the balance of the year's profits is carried to the credit of undivided profits, or surplus, or some other account having like significance. If thereafter the company finds itself in funds beyond current needs, it may declare dividends out of such surplus or undivided profits; otherwise it may go on for years conducting a successful business, but requiring more and more working capital because of the extension of its operations, and therefore unable to declare dividends approximating the amount of its profits. Thus, the surplus may increase until it equals or even exceeds the par value of the outstanding capital stock. This may be adjusted upon the books in the mode adopted in the case at bar -- by declaring a "stock dividend." This, however, is no more than a book adjustment, in essence -- not a dividend, but rather the opposite; no part of the assets of the company is separated from the common fund, nothing distributed except paper certificates that evidence an antecedent increase in the value of the stockholder's capital interest resulting from an accumulation of profits by the company, but profits so far absorbed in the business as to render it impracticable to separate them for withdrawal and distribution. In order to make the adjustment, a charge is made against surplus account with corresponding credit to capital stock account, equal to the proposed "dividend;" the new stock is issued against this and the certificates delivered to the existing stockholders in proportion to their previous holdings. This, however, is merely bookkeeping that does not affect the aggregate assets of the corporation or its outstanding liabilities; it affects only the form,

not the essence, of the "liability" acknowledged by the corporation to its own shareholders, and this through a readjustment of accounts on one side of the balance sheet only, increasing "capital stock" at the expense of Page 252 U. S. 211 "surplus"; it does not alter the preexisting proportionate interest of any stockholder or increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they stood before. The new certificates simply increase the number of the shares, with consequent dilution of the value of each share. A "stock dividend" shows that the company's accumulated profits have been capitalized, instead of distributed to the stockholders or retained as surplus available for distribution in money or in kind should opportunity offer. Far from being a realization of profits of the stockholder, it tends rather to postpone such realization, in that the fund represented by the new stock has been transferred from surplus to capital, and no longer is available for actual distribution. The essential and controlling fact is that the stockholder has received nothing out of the company's assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations have resulted from employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance and not to form, he has received nothing that answers the definition of income within the meaning of the Sixteenth Amendment.

Being concerned only with the true character and effect of such a dividend when lawfully made, we lay aside the question whether, in a particular case, a stock dividend may be authorized by the local law governing the corporation, or whether the capitalization of profits may be the result of correct judgment and proper business policy on the part of its management, and a due regard for the interests of the stockholders. And we are considering the taxability of bona fide stock dividends only. Page 252 U. S. 212 We are clear that not only does a stock dividend really take nothing from the property of the corporation and add nothing to that of the shareholder, but that the antecedent accumulation of profits evidenced thereby, while indicating that the shareholder is the richer because of an increase of his capital, at the same time shows he has not realized or received any income in the transaction. It is said that a stockholder may sell the new shares acquired in the stock dividend, and so he may, if he can find a buyer. It is equally true that, if he does sell, and in doing so realizes a profit, such profit, like any other, is income, and, so far as it may have arisen since the Sixteenth Amendment, is taxable by Congress without apportionment. The same would be true were he to sell some of his original shares at a profit. But if a shareholder sells dividend stock, he necessarily disposes of a part of his capital interest, just as if he should sell a part of his old stock, either before or after the dividend. What he retains no longer entitles him to the same proportion of future dividends as before the sale. His part in the control of the company likewise is diminished. Thus, if one holding $60,000 out of a total $100,000 of the capital stock of a corporation should receive in common with other stockholders a 50

percent stock dividend, and should sell his part, he thereby would be reduced from a majority to a minority stockholder, having six-fifteenths instead of six-tenths of the total stock outstanding. A corresponding and proportionate decrease in capital interest and in voting power would befall a minority holder should he sell dividend stock, it being in the nature of things impossible for one to dispose of any part of such an issue without a proportionate disturbance of the distribution of the entire capital stock and a like diminution of the seller's comparative voting power -- that "right preservative of rights" in the control of a corporation. Page 252 U. S. 213 Yet, without selling, the shareholder, unless possessed of other resources, has not the wherewithal to pay an income tax upon the dividend stock. Nothing could more clearly show that to tax a stock dividend is to tax a capital increase, and not income, than this demonstration that, in the nature of things, it requires conversion of capital in order to pay the tax. Throughout the argument of the government, in a variety of forms, runs the fundamental error already mentioned -- a failure to appraise correctly the force of the term "income" as used in the Sixteenth Amendment, or at least to give practical effect to it. Thus, the government contends that the tax "is levied on income derived from corporate earnings," when in truth the stockholder has "derived" nothing except paper certificates, which, so far as they have any effect, deny him present participation in such earnings. It contends that the tax may be laid when earnings "are received by the stockholder," whereas he has received none; that the profits are "distributed by means of a stock dividend," although a stock dividend distributes no profits; that, under the Act of 1916, "the tax is on the stockholder's share in corporate earnings," when in truth a

stockholder has no such share, and receives none in a stock dividend; that "the profits are segregated from his former capital, and he has a separate certificate representing his invested profits or gains," whereas there has been no segregation of profits, nor has he any separate certificate representing a personal gain, since the certificates, new and old, are alike in what they represent -- a capital interest in the entire concerns of the corporation. We have no doubt of the power or duty of a court to look through the form of the corporation and determine the question of the stockholder's right in order to ascertain whether he has received income taxable by Congress without apportionment. But, looking through the form, Page 252 U. S. 214 we cannot disregard the essential truth disclosed, ignore the substantial difference between corporation and stockholder, treat the entire organization as unreal, look upon stockholders as partners when they are not such, treat them as having in equity a right to a partition of the corporate assets when they have none, and indulge the fiction that they have received and realized a share of the profits of the company which in truth they have neither received nor realized. We must treat the corporation as a substantial entity separate from the stockholder not only because such is the practical fact, but because it is only by recognizing such separateness that any dividend -- even one paid in money or property -- can be regarded as income of the stockholder. Did we regard corporation and stockholders as altogether identical, there would be no income except as the corporation acquired it, and while this would be taxable against the corporation as income under appropriate provisions of law, the individual stockholders could not be separately and additionally taxed

with respect to their several shares even when divided, since, if there were entire identity between them and the company, they could not be regarded as receiving anything from it, any more than if one's money were to be removed from one pocket to another. Conceding that the mere issue of a stock dividend makes the recipient no richer than before, the government nevertheless contends that the new certificates measure the extent to which the gains accumulated by the corporation have made him the richer. There are two insuperable difficulties with this. In the first place, it would depend upon how long he had held the stock whether the stock dividend indicated the extent to which he had been enriched by the operations of the company; unless he had held it throughout such operations, the measure would not hold true. Secondly, and more important for present purposes, enrichment through increase in value Page 252 U. S. 215 of capital investment is not income in any proper meaning of the term. The complaint contains averments respecting the market prices of stock such as plaintiff held, based upon sales before and after the stock dividend, tending to show that the receipt of the additional shares did not substantially change the market value of her entire holdings. This tends to show that, in this instance, market quotations reflected intrinsic values -- a thing they do not always do. But we regard the market prices of the securities as an unsafe criterion in an inquiry such as the present, when the question must be not what will the thing sell for, but what is it in truth and in essence. It is said there is no difference in principle between a simple stock dividend and a case where stockholders use money

received as cash dividends to purchase additional stock contemporaneously issued by the corporation. But an actual cash dividend, with a real option to the stockholder either to keep the money for his own or to reinvest it in new shares, would be as far removed as possible from a true stock dividend, such as the one we have under consideration, where nothing of value is taken from the company's assets and transferred to the individual ownership of the several stockholders and thereby subjected to their disposal. The government's reliance upon the supposed analogy between a dividend of the corporation's own shares and one made by distributing shares owned by it in the stock of another company calls for no comment beyond the statement that the latter distributes assets of the company among the shareholders, while the former does not, and for no citation of authority except Peabody v. Eisner, 247 U. S. 347, 247 U. S. 349-350. Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of the position of the government. Page 252 U. S. 216 Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231, arose under the Dividend Duties Act of Western Australia, which provided that "dividend" should include "every dividend, profit, advantage, or gain intended to be paid or credited to or distributed among any members or directors of any company," except, etc. There was a stock dividend, the new shares being allotted among the shareholders pro rata, and the question was whether this was a distribution of a dividend within the meaning of the act. The Judicial Committee of the Privy Council sustained the dividend duty upon the ground that, although "in ordinary language the new shares would not be

called a dividend, nor would the allotment of them be a distribution of a dividend," yet, within the meaning of the act, such new shares were an "advantage" to the recipients. There being no constitutional restriction upon the action of the lawmaking body, the case presented merely a question of statutory construction, and manifestly the decision is not a precedent for the guidance of this Court when acting under a duty to test an act of Congress by the limitations of a written Constitution having superior force. In Tax Commissioner v. Putnam, (1917) 227 Mass. 522, it was held that the Forty-Fourth amendment to the Constitution of Massachusetts, which conferred upon the legislature full power to tax incomes, "must be interpreted as including every item which by any reasonable understanding can fairly be regarded as income" (pp. 526, 531), and that under it, a stock dividend was taxable as income, the court saying (p. 535): "In essence, the thing which has been done is to distribute a symbol representing an accumulation of profits, which, instead of being paid out in cash, is invested in the business, thus augmenting its durable assets. In this aspect of the case, the substance of the transaction is no different from what it would be if a cash dividend had been declared with the privilege of subscription to an equivalent amount of new shares. " Page 252 U. S. 217 We cannot accept this reasoning. Evidently, in order to give a sufficiently broad sweep to the new taxing provision, it was deemed necessary to take the symbol for the substance, accumulation for distribution, capital accretion for its opposite, while a case where money is paid into the hand of the stockholder with an option to buy new shares with it, followed by acceptance of the option, was regarded as identical in substance with a case where the stockholder receives no

money and has no option. The Massachusetts court was not under an obligation, like the one which binds us, of applying a constitutional amendment in the light of other constitutional provisions that stand in the way of extending it by construction. Upon the second argument, the government, recognizing the force of the decision inTowne v. Eisner, supra, and virtually abandoning the contention that a stock dividend increases the interest of the stockholder or otherwise enriches him, insisted as an alternative that, by the true construction of the Act of 1916, the tax is imposed not upon the stock dividend, but rather upon the stockholder's share of the undivided profits previously accumulated by the corporation, the tax being levied as a matter of convenience at the time such profits become manifest through the stock dividend. If so construed, would the act be constitutional? That Congress has power to tax shareholders upon their property interests in the stock of corporations is beyond question, and that such interests might be valued in view of the condition of the company, including its accumulated and undivided profits, is equally clear. But that this would be taxation of property because of ownership, and hence would require apportionment under the provisions of the Constitution, is settled beyond peradventure by previous decisions of this Court. The government relies upon Collector v. Hubbard, (1870) Page 252 U. S. 218 12 Wall. 1, which arose under 117 of the Act of June 30, 1864, c. 173, 13 Stat. 223, 282, providing that "The gains and profits of all companies, whether incorporated or partnership, other than the companies specified in that section, shall be included in estimating the annual gains,

profits, or income of any person, entitled to the same, whether divided or otherwise." The court held an individual taxable upon his proportion of the earnings of a corporation although not declared as dividends and although invested in assets not in their nature divisible. Conceding that the stockholder for certain purposes had no title prior to dividend declared, the court nevertheless said (p. 79 U. S. 18): "Grant all that, still it is true that the owner of a share of stock in a corporation holds the share with all its incidents, and that among those incidents is the right to receive all future dividends -- that is, his proportional share of all profits not then divided. Profits are incident to the share to which the owner at once becomes entitled provided he remains a member of the corporation until a dividend is made. Regarded as an incident to the shares, undivided profits are property of the shareholder, and as such are the proper subject of sale, gift, or devise. Undivided profits invested in real estate, machinery, or raw material for the purpose of being manufactured are investments in which the stockholders are interested, and when such profits are actually appropriated to the payment of the debts of the corporation, they serve to increase the market value of the shares, whether held by the original subscribers or by assignees." Insofar as this seems to uphold the right of Congress to tax without apportionment a stockholder's interest in accumulated earnings prior to dividend declared, it must be regarded as overruled by Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, 158 U. S. 627-628, 158 U. S. 637. Conceding Collector v. Hubbard was inconsistent with the doctrine of that case, because it sustained a direct tax upon property not apportioned

Page 252 U. S. 219 among the states, the government nevertheless insists that the sixteenth Amendment removed this obstacle, so that now the Hubbard case is authority for the power of Congress to levy a tax on the stockholder's share in the accumulated profits of the corporation even before division by the declaration of a dividend of any kind. Manifestly this argument must be rejected, since the amendment applies to income only, and what is called the stockholder's share in the accumulated profits of the company is capital, not income. As we have pointed out, a stockholder has no individual share in accumulated profits, nor in any particular part of the assets of the corporation, prior to dividend declared. Thus, from every point of view, we are brought irresistibly to the conclusion that neither under the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder. The Revenue Act of 1916, insofar as it imposes a tax upon the stockholder because of such dividend, contravenes the provisions of Article I, 2, cl. 3, and Article I, 9, cl. 4, of the Constitution, and to this extent is invalid notwithstanding the Sixteenth Amendment. Judgment affirmed. * "Title I. -- Income Tax" "Part I. -- On Individuals" "Sec. 2. (a) That, subject only to such exemptions and deductions as are hereinafter allowed, the net income of a taxable person shall include gains, profits, and income

derived, . . . also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever: Provided, that the term 'dividends' as used in this title shall be held to mean any distribution made or ordered to be made by a corporation, . . . out of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its shareholders, whether, in cash or in stock of the corporation, . . . which stock dividend shall be considered income, to the amount of its cash value." MR. JUSTICE HOLMES, dissenting. I think that Towne v. Eisner, 245 U. S. 418, was right in its reasoning and result, and that, on sound principles, the stock dividend was not income. But it was clearly intimated in that case that the construction of the statute then before the Court might be different from that of the Constitution. 245 U.S. 245 U. S. 425. I think that the word "incomes" in the Sixteenth Amendment should be read in Page 252 U. S. 220 "a sense most obvious to the common understanding at the time of its adoption."Bishop v. State, 149 Ind. 223, 230; State v. Butler, 70 Fla. 102, 133. For it was for public adoption that it was proposed. McCulloch v. Maryland, 4 Wheat. 316, 17 U. S. 407. The known purpose of this Amendment was to get rid of nice questions as to what might be direct taxes, and I cannot doubt that most people not lawyers would suppose when they voted for it that they put a question like the present to rest. I am of opinion that the Amendment justifies the tax. See Tax Commissioner v. Putnam,227 Mass. 522, 532, 533. MR. JUSTICE DAY concurs in this opinion. MR. JUSTICE BRANDEIS delivered the following opinion, in

which MR. JUSTICE CLARKE concurred. Financiers, with the aid of lawyers, devised long ago two different methods by which a corporation can, without increasing its indebtedness, keep for corporate purposes accumulated profits, and yet, in effect, distribute these profits among its stockholders. One method is a simple one. The capital stock is increased; the new stock is paid up with the accumulated profits, and the new shares of paid-up stock are then distributed among the stockholders pro rata as a dividend. If the stockholder prefers ready money to increasing his holding of the stock in the company, he sells the new stock received as a dividend. The other method is slightly more complicated. .arrangements are made for an increase of stock to be offered to stockholders pro rata at par, and at the same time for the payment of a cash dividend equal to the amount which the stockholder will be required to pay to Page 252 U. S. 221 the company, if he avails himself of the right to subscribe for his pro rata of the new stock. If the stockholder takes the new stock, as is expected, he may endorse the dividend check received to the corporation, and thus pay for the new stock. In order to ensure that all the new stock so offered will be taken, the price at which it is offered is fixed far below what it is believed will be its market value. If the stockholder prefers ready money to an increase of his holdings of stock, he may sell his right to take new stock pro rata, which is evidenced by an assignable instrument. In that event the purchaser of the rights repays to the corporation, as the subscription price of the new stock, an amount equal to that which it had paid as a cash dividend to the stockholder. Both of these methods of retaining accumulated profits while in effect distributing them as a dividend had been in common use

in the United States for many years prior to the adoption of the Sixteenth Amendment. They were recognized equivalents. Whether a particular corporation employed one or the other method was determined sometimes by requirements of the law under which the corporation was organized; sometimes it was determined by preferences of the individual officials of the corporation, and sometimes by stock market conditions. Whichever method was employed, the resultant distribution of the new stock was commonly referred to as a stock dividend. How these two methods have been employed may be illustrated by the action in this respect (as reported in Moody's Manual, 1918 Industrial, and the Commercial and Financial Chronicle) of some of the Standard Oil companies since the disintegration pursuant to the decision of this Court in 1911. Standard Oil Co. v. United States, 221 U. S. 1. (a) Standard Oil Co. (of Indiana), an Indiana corporation. It had on December 31, 1911, $1,000,000 capital stock (all common), and a large surplus. On May 15, Page 252 U. S. 222 1912, it increased its capital stock to $30,000,000, and paid a simple stock dividend of 2,900 percent in stock. [Footnote 1] (b) Standard Oil Co. (of Nebraska), a Nebraska corporation. It had on December 31, 1911, $600,000 capital stock (all common), and a substantial surplus. On April 15, 1912, it paid a simple stock dividend of 33 1/3 percent, increasing the outstanding capital to $800,000. During the calendar year 1912, it paid cash dividends aggregating 20 percent, but it earned considerably more, and had at the close of the year again a substantial surplus. On June 20, 1913, it declared a further stock dividend of 25 percent, thus increasing the capital to $1,000,000. [Footnote 2]

(c) The Standard Oil Co. (of Kentucky), a Kentucky corporation. It had on December 31, 1913, $1,000,000 capital stock (all common) and $3,701,710 surplus. Of this surplus, $902,457 had been earned during the calendar year 1913, the net profits of that year having been $1,002,457 and the dividends paid only $100,000 (10 percent). On December 22, 1913, a cash dividend of $200 per share was declared payable on February 14, 1914, to stockholders of record January 31, 1914, and these stockholders were offered the right to subscribe for an equal amount of new stock at par and to apply the cash dividend in payment therefor. The outstanding stock was thus increased to $3,000,000. During the calendar years 1914, 1915, and 1916, quarterly dividends were paid on this stock at an annual rate of between 15 percent and 20 percent, but the company's surplus increased by $2,347,614, so that, on December 31, 1916, it had a large surplus over its $3,000,000 capital stock. On December 15, 1916, the company issued a circular to the stockholders, saying: "The company's business for this year has shown a Page 252 U. S. 223 very good increase in volume and a proportionate increase in profits, and it is estimated that, by January 1, 1917, the company will have a surplus of over $4,000,000. The board feels justified in stating that, if the proposition to increase the capital stock is acted on favorably, it will be proper in the near future to declare a cash dividend of 100 percent and to allow the stockholders the privilege pro rata according to their holdings, to purchase the new stock at par, the plan being to allow the stockholders, if they desire, to use their cash dividend to pay for the new stock." The increase of stock was voted. The company then paid a cash dividend of 100 percent, payable May 1, 1917, again

offering to such stockholders the right to subscribe for an equal amount of new stock at par and to apply the cash dividend in payment therefor. Moody's Manual, describing the transaction with exactness, says first that the stock was increased from $3,000,000 to $6,000,000, "a cash dividend of 100 percent, payable May 1, 1917, being exchanged for one share of new stock, the equivalent of a 100 percent stock dividend." But later in the report giving, as customary in the Manual, the dividend record of the company, the Manual says: "A stock dividend of 200 percent was paid February 14, 1914, and one of 100 percent on May 1, 1197." And, in reporting specifically the income account of the company for a series of years ending December 31, covering net profits, dividends paid, and surplus for the year, it gives, as the aggregate of dividends for the year 1917, $660,000 (which was the aggregate paid on the quarterly cash dividend -- 5 percent January and April; 6 percent July and October), and adds in a note: "In addition, a stock dividend of 100 percent was paid during the year." [Footnote 3] The Wall Street Journal of Page 252 U. S. 224 May 2, 1917, p. 2, quotes the 1917 "high" price for Standard Oil of Kentucky as "375 ex stock dividend." It thus appears that, among financiers and investors, the distribution of the stock, by whichever method effected, is called a stock dividend; that the two methods by which accumulated profits are legally retained for corporate purposes and at the same time distributed as dividends are recognized by them to be equivalents, and that the financial results to the corporation and to the stockholders of the two methods are substantially the same, unless a difference results from the application of the federal income tax law.

Mrs. Macomber, a citizen and resident of New York, was, in the year 1916, a stockholder in the Standard Oil Company (of California), a corporation organized under the laws of California and having its principal place of business in that state. During that year, she received from the company a stock dividend representing profits earned since March 1, 1913. The dividend was paid by direct issue of the stock to her according to the simple method described above, pursued also by the Indiana and Nebraska companies. In 1917, she was taxed under the federal law on the stock dividend so received at its par value of $100 a share, as income received during the year 1916. Such a stock dividend is income, as distinguished from capital, both under the law of New York and under the law of California, because in both states every dividend representing profits is deemed to be income, whether paid in cash or in stock. It had been so held in New York, where the question arose as between life tenant and remainderman, Lowry v. Farmers' Loan & Trust Co., 172 N.Y. 137; Matter of Osborne, 209 N.Y. 450, and also, where the question arose in matters of taxation, People v. Glynn, Page 252 U. S. 225 130 App.Div. 332, 198 N.Y. 605. It has been so held in California, where the question appears to have arisen only in controversies between life tenant and remainderman. Estate of Duffill, 58 Cal.Dec. 97, 180 Cal. 748. It is conceded that, if the stock dividend paid to Mrs. Macomber had been made by the more complicated method pursued by the Standard Oil Company of Kentucky -- that is, issuing rights to take new stock pro rata and paying to each stockholder simultaneously a dividend in cash sufficient in amount to enable him to pay for this pro rata of new stock to be purchased -- the dividend so paid to him would have been

taxable as income, whether he retained the cash or whether he returned it to the corporation in payment for his pro rata of new stock. But it is contended that, because the simple method was adopted of having the new stock issued direct to the stockholders as paid-up stock, the new stock is not to be deemed income, whether she retained it or converted it into cash by sale. If such a different result can flow merely from the difference in the method pursued, it must be because Congress is without power to tax as income of the stockholder either the stock received under the latter method or the proceeds of its sale, for Congress has, by the provisions in the Revenue Act of 1916, expressly declared its purpose to make stock dividends, by whichever method paid, taxable as income. The Sixteenth Amendment, proclaimed February 25, 1913, declares: "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration." The Revenue Act of September 8, 1916, c. 463, 2a, 39 Stat. 756, 757, provided: "That the term 'dividends' as used in this title shall Page 252 U. S. 226 be held to mean any distribution made or ordered to be made by a corporation, . . . out of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its shareholders, whether in cash or in stock of the corporation, . . . which stock dividend shall be considered income, to the amount of its cash value."

Hitherto, powers conferred upon Congress by the Constitution have been liberally construed, and have been held to extend to every means appropriate to attain the end sought. In determining the scope of the power, the substance of the transaction, not its form, has been regarded. Martin v. Hunter, 1 Wheat. 304, 14 U. S. 326; McCulloch v. Maryland, 4 Wheat. 316, 17 U. S. 407, 17 U. S. 415; Brown v. Maryland, 12 Wheat. 419, 25 U. S. 446; Craig v. Missouri, 4 Pet. 410, 29 U. S. 433; Jarrolt v. Moberly, 103 U. S. 580, 103 U. S. 585-587; Legal Tender Case, 110 U. S. 421, 110 U. S. 444;Lithograph Co. v. Sarony, 111 U. S. 53, 111 U. S. 58; United States v. Realty Co., 163 U. S. 427, 163 U. S. 440442; South Carolina v. United States, 199 U. S. 437, 199 U. S. 448-449. Is there anything in the phraseology of the Sixteenth Amendment or in the nature of corporate dividends which should lead to a departure from these rules of construction and compel this Court to hold that Congress is powerless to prevent a result so extraordinary as that here contended for by the stockholder? First. The term "income," when applied to the investment of the stockholder in a corporation, had, before the adoption of the Sixteenth Amendment, been commonly understood to mean the returns from time to time received by the stockholder from gains or earnings of the corporation. A dividend received by a stockholder from a corporation may be either in distribution of capital assets or in distribution of profits. Whether it is the one or the other is in no way affected by the medium in which it is paid, nor by the method or means through which the particular thing distributed as a dividend was procured. If the Page 252 U. S. 227 dividend is declared payable in cash, the money with which to pay it is ordinarily taken from surplus cash in the treasury. But

(if there are profits legally available for distribution and the law under which the company was incorporated so permits) the company may raise the money by discounting negotiable paper, or by selling bonds, scrip or stock of another corporation then in the treasury, or by selling its own bonds, scrip or stock then in the treasury, or by selling its own bonds, scrip or stock issued expressly for that purpose. How the money shall be raised is wholly a matter of financial management. The manner in which it is raised in no way affects the question whether the dividend received by the stockholder is income or capital, nor can it conceivably affect the question whether it is taxable as income. Likewise whether a dividend declared payable from profits shall be paid in cash or in some other medium is also wholly a matter of financial management. If some other medium is decided upon, it is also wholly a question of financial management whether the distribution shall be, for instance, in bonds, scrip or stock of another corporation or in issues of its own. And if the dividend is paid in its own issues, why should there be a difference in result dependent upon whether the distribution was made from such securities then in the treasury or from others to be created and issued by the company expressly for that purpose? So far as the distribution may be made from its own issues of bonds, or preferred stock created expressly for the purpose, it clearly would make no difference, in the decision of the question whether the dividend was a distribution of profits, that the securities had to be created expressly for the purpose of distribution. If a dividend paid in securities of that nature represents a distribution of profits, Congress may, of course, tax it as income of the stockholder. Is the result different where the security distributed is common stock? Page 252 U. S. 228

Suppose that a corporation having power to buy and sell its own stock purchases, in the interval between its regular dividend dates, with moneys derived from current profits, some of its own common stock as a temporary investment, intending at the time of purchase to sell it before the next dividend date and to use the proceeds in paying dividends, but later, deeming it inadvisable either to sell this stock or to raise by borrowing the money necessary to pay the regular dividend in cash, declares a dividend payable in this stock; can anyone doubt that, in such a case, the dividend in common stock would be income of the stockholder and constitutionally taxable as such? See Green v. Bissell, 79 Conn. 547; Leland v. Hayden, 102 Mass. 542. And would it not likewise be income of the stockholder subject to taxation if the purpose of the company in buying the stock so distributed had been from the beginning to take it off the market and distribute it among the stockholders as a dividend, and the company actually did so? And, proceeding a short step further, suppose that a corporation decided to capitalize some of its accumulated profits by creating additional common stock and selling the same to raise working capital, but after the stock has been issued and certificates therefor are delivered to the bankers for sale, general financial conditions make it undesirable to market the stock, and the company concludes that it is wiser to husband, for working capital, the cash which it had intended to use in paying stockholders a dividend, and, instead, to pay the dividend in the common stock which it had planned to sell; would not the stock so distributed be a distribution of profits, and hence, when received, be income of the stockholder and taxable as such? If this be conceded, why should it not be equally income of the stockholder, and taxable as such, if the common stock created by capitalizing profits had been originally created for the express purpose of being distributed

Page 252 U. S. 229 as a dividend to the stockholder who afterwards received it? Second. It has been said that a dividend payable in bonds or preferred stock created for the purpose of distributing profits may be income and taxable as such, but that the case is different where the distribution is in common stock created for that purpose. Various reasons are assigned for making this distinction. One is that the proportion of the stockholder's ownership to the aggregate number of the shares of the company is not changed by the distribution. But that is equally true where the dividend is paid in its bonds or in its preferred stock. Furthermore, neither maintenance nor change in the proportionate ownership of a stockholder in a corporation has any bearing upon the question here involved. Another reason assigned is that the value of the old stock held is reduced approximately by the value of the new stock received, so that the stockholder, after receipt of the stock dividend, has no more than he had before it was paid. That is equally true whether the dividend be paid in cash or in other property -- for instance, bonds, scrip, or preferred stock of the company. The payment from profits of a large cash dividend, and even a small one, customarily lowers the then market value of stock because the undivided property represented by each share has been correspondingly reduced. The argument which appears to be most strongly urged for the stockholders is that, when a stock dividend is made, no portion of the assets of the company is thereby segregated for the stockholder. But does the issue of new bonds or of preferred stock created for use as a dividend result in any segregation of assets for the stockholder? In each case, he receives a piece of paper which entitles him to certain rights in the undivided property. Clearly, segregation of assets in a physical sense is not an essential of income. The year's gains of a partner is taxable as income

although there likewise no Page 252 U. S. 230 segregation of his share in the gains from that of his partners is had. The objection that there has been no segregation is presented also in another form. It is argued that, until there is a segregation, the stockholder cannot know whether he has really received gains, since the gains may be invested in plant or merchandise or other property, and perhaps be later lost. But is not this equally true of the share of a partner in the year's profits of the firm or, indeed, of the profits of the individual who is engaged in business alone? And is it not true also when dividends are paid in cash? The gains of a business, whether conducted by an individual, by a firm, or by a corporation are ordinarily reinvested in large part. Many a cash dividend honestly declared as a distribution of profits proves later to have been paid out of capital because errors in forecast prevent correct ascertainment of values. Until a business adventure has been completely liquidated, it can never be determined with certainty whether there have been profits unless the returns at least exceeded the capital originally invested. Businessmen, dealing with the problem practically, fix necessarily periods and rules for determining whether there have been net profits -- that is, income or gains. They protect themselves from being seriously misled by adopting a system of depreciation charges and reserves. Then they act upon their own determination whether profits have been made. Congress, in legislating, has wisely adopted their practices as its own rules of action. Third. The government urges that it would have been within the power of Congress to have taxed as income of the stockholder his pro rata share of undistributed profits earned

even if no stock dividend representing it had been paid. Strong reasons may be assigned for such a view. See Collector v. Hubbard, 12 Wall. 1. The undivided share of a partner in the year's undistributed profits of his firm Page 252 U. S. 231 is taxable as income of the partner although the share in the gain is not evidenced by any action taken by the firm. Why may not the stockholder's interest in the gains of the company? The law finds no difficulty in disregarding the corporate fiction whenever that is deemed necessary to attain a just result. Linn Timber Co. v. United States, 236 U. S. 574. See Morawetz on Corporations, 2d ed., 227-231; Cook on Corporations, 7th ed., 663, 664. The stockholder's interest in the property of the corporation differs not fundamentally, but in form only, from the interest of a partner in the property of the firm. There is much authority for the proposition that, under our law, a partnership or joint stock company is just as distinct and palpable an entity in the idea of the law, as distinguished from the individuals composing it, as is a corporations. [Footnote 4] No reason appears, why Congress, in legislating under a grant of power so comprehensive as that authorizing the levy of an income tax, should be limited by the particular view of the relation of the stockholder to the corporation and its property which may, in the absence of legislation, have been taken by this Court. But we have no occasion to decide the question whether Congress might have taxed to the stockholder his undivided share of the corporation's earnings. For Congress has in this act limited the income tax to that share of the stockholder in the earnings which is, in effect, distributed by means of the stock dividend paid. In other words, to render the stockholder taxable, there must be both earnings made and a dividend paid. Neither earnings without dividend nor a dividend without earnings

subjects the Page 252 U. S. 232 stockholder to taxation under the Revenue Act of 1916. Fourth. The equivalency of all dividends representing profits, whether paid of all dividends in stock, is so complete that serious question of the taxability of stock dividends would probably never have been made if Congress had undertaken to tax only those dividends which represented profits earned during the year in which the dividend was paid or in the year preceding. But this Court, construing liberally not only the constitutional grant of power but also the revenue Act of 1913, held that Congress might tax, and had taxed, to the stockholder dividends received during the year, although earned by the company long before, and even prior to the adoption of the Sixteenth Amendment. Lynch v. Hornby, 247 U. S. 339. [Footnote 5] That rule, if indiscriminatingly applied to all stock dividends representing profits earned, might, in view of corporate practice, have worked considerable hardship and have raised serious questions. Many corporations, without legally capitalizing any part of their profits, had assigned definitely some part or all of the annual balances remaining after paying the usual cash dividends to the uses to which permanent capital is ordinarily applied. Some of the corporations doing this transferred such balances on their books to "surplus" account -- distinguishing between such permanent "surplus" and the "undivided profits" account. Other corporations, without this formality, had assumed that the annual accumulating balances carried as undistributed profits were to be treated as capital permanently invested in the business. And still others, without definite assumption of any kind, had Page 252 U. S. 233

so used undivided profits for capital purposes. To have made the revenue law apply retroactively so as to reach such accumulated profits, if and whenever it should be deemed desirable to capitalize them legally by the issue of additional stock distributed as a dividend to stockholders, would have worked great injustice. Congress endeavored in the Revenue Act of 1916 to guard against any serious hardship which might otherwise have arisen from making taxable stock dividends representing accumulated profits. It did not limit the taxability to stock dividends representing profits earned within the tax year or in the year preceding, but it did limit taxability to such dividends representing profits earned since March 1, 1913. Thereby stockholders were given notice that their share also in undistributed profits accumulating thereafter was at some time to be taxed as income. And Congress sought by 3 to discourage the postponement of distribution for the illegitimate purpose of evading liability to surtaxes. Fifth. The decision of this Court that earnings made before the adoption of the Sixteenth Amendment, but paid out in cash dividend after its adoption, were taxable as income of the stockholder involved a very liberal construction of the amendment. To hold now that earnings both made and paid out after the adoption of the Sixteenth Amendment cannot be taxed as income of the stockholder, if paid in the form of a stock dividend, involves an exceedingly narrow construction of it. As said by Mr. Chief Justice Marshall in Brown v. Maryland, 12 Wheat. 419, 25 U. S. 446: "To construe the power so as to impair its efficacy would tend to defeat an object in the attainment of which the American public took, and justly took, that strong interest which arose from a full conviction of its necessity." No decision heretofore rendered by this Court requires us to

hold that Congress, in providing for the taxation of Page 252 U. S. 234 stock dividends, exceeded the power conferred upon it by the Sixteenth Amendment. The two cases mainly relied upon to show that this was beyond the power of Congress are Towne v. Eisner, 245 U. S. 418, which involved a question not of constitutional power, but of statutory construction, and Gibbons v. Mahon, 136 U. S. 549, which involved a question arising between life tenant and remainderman. So far as concernsTowne v. Eisner, we have only to bear in mind what was there said (p. 245 U. S. 425): "But it is not necessarily true that income means the same thing in the Constitution and the [an] act." [Footnote 6] Gibbons v. Mahon is even less an authority for a narrow construction of the power to tax incomes conferred by the Sixteenth Amendment. In that case, the court was required to determine how, in the administration of an estate in the District of Columbia, a stock dividend, representing profits, received after the decedent's death, should be disposed of as between life tenant and remainderman. The question was, in essence, what shall the intention of the testator be presumed to have been? On this question, there was great diversity of opinion and practice in the courts of English-speaking countries. Three well defined rules were then competing for acceptance. Two of these involves an arbitrary rule of distribution, the third equitable apportionment. See Cook on Corporations, 7th ed., 552-558. 1. The so-called English rule, declared in 1799 by Brander v. Brander, 4 Ves. Jr. 800, that a dividend representing Page 252 U. S. 235 profits, whether in cash, stock or other property, belongs to the

life tenant if it was a regular or ordinary dividend, and belongs to the remainderman if it was an extraordinary dividend. 2. The so-called Massachusetts rule, declared in 1868 by Minot v. Paine, 99 Mass. 101, that a dividend representing profits, whether regular, ordinary, or extraordinary, if in cash belongs to the life tenant, and if in stock belongs to the remainderman. 3. The so-called Pennsylvania rule, declared in 1857 by Earp's Appeal, 28 Pa. 368, that, where a stock dividend is paid, the court shall inquire into the circumstances under which the fund had been earned and accumulated out of which the dividend, whether a regular, an ordinary, or an extraordinary one, was paid. If it finds that the stock dividend was paid out of profits earned since the decedent's death, the stock dividend belongs to the life tenant; if the court finds that the stock dividend was paid from capital or from profits earned before the decedent's death, the stock dividend belongs to the remainderman. This Court adopted in Gibbons v. Mahon as the rule of administration for the District of Columbia the so-called Massachusetts rule, the opinion being delivered in 1890 by Mr. Justice Gray. Since then, the same question has come up for decision in many of the states. The so-called Massachusetts rule, although approved by this Court, has found favor in only a few states. The so-called Pennsylvania rule, on the other hand, has been adopted since by so many of the states (including New York and California) that it has come to be known as the "American rule." Whether, in view of these facts and the practical results of the operation of the two rules as shown by the experience of the 30 years which have elapsed since the decision in Gibbons v. Mahon, it might be desirable for this Court to reconsider the question there decided, as Page 252 U. S. 236

some other courts have done (see 29 Harvard Law Review 551), we have no occasion to consider in this case. For, as this Court there pointed out (p. 136 U. S. 560), the question involved was one "between the owners of successive interests in particular shares," and not, as in Bailey v. Railroad Co., 22 Wall. 604, a question "between the corporation and the government, and [which] depended upon the terms of a statute carefully framed to prevent corporations from evading payment of the tax upon their earnings." We have, however, not merely argument; we have examples which should convince us that "there is no inherent, necessary and immutable reason why stock dividends should always be treated as capital." Tax Commissioner v. Putnam, 227 Mass. 522, 533. The Supreme Judicial Court of Massachusetts has steadfastly adhered, despite ever-renewed protest, to the rule that every stock dividend is, as between life tenant and remainderman, capital, and not income. But, in construing the Massachusetts Income Tax Amendment, which is substantially identical with the federal amendment, that court held that the legislature was thereby empowered to levy an income tax upon stock dividends representing profits. The courts of England have, with some relaxation, adhered to their rule that every extraordinary dividend is, as between life tenant and remainderman, to be deemed capital. But, in 1913, the Judicial Committee of the Privy Council held that a stock dividend representing accumulated profits was taxable like an ordinary cash dividend, Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231. In dismissing the appeal, these words of the Chief Justice of the Supreme Court of Western Australia were quoted (p. 236), which show that the facts involved were identical with those in the case at bar:

"Had the company distributed the 101,450 among the shareholders, and had the shareholders repaid such sums to the company as the price of the 81, 160 new shares, the duty on the 101,450 Page 252 U. S. 237 would clearly have been payable. Is not this virtually the effect of what was actually done? I think it is." Sixth. If stock dividends representing profits are held exempt from taxation under the Sixteenth Amendment, the owners of the most successful businesses in America will, as the facts in this case illustrate, be able to escape taxation on a large part of what is actually their income. So far as their profits are represented by stock received as dividends, they will pay these taxes not upon their income, but only upon the income of their income. That such a result was intended by the people of the United States when adopting the Sixteenth Amendment is inconceivable. Our sole duty is to ascertain their intent as therein expressed. [Footnote 7] In terse, comprehensive language befitting the Constitution, they empowered Congress "to lay and collect taxes on incomes from whatever source derived." They intended to include thereby everything which by reasonable understanding can fairly be regarded as income. That stock dividends representing profits are so regarded not only by the plain people, but by investors and financiers and by most of the courts of the country, is shown beyond peradventure by their acts and by their utterances. It seems to me clear, therefore, that Congress possesses the power which it exercised to make dividends representing profits taxable as income whether the medium in which the dividend is paid be cash or stock, and that it may define, as it has done, what dividends representing Page 252 U. S. 238

profits shall be deemed income. It surely is not clear that the enactment exceeds the power granted by the Sixteenth Amendment. And, as this Court has so often said, the high prerogative of declaring an act of Congress invalid should never be exercised except in a clear case. [Footnote 8] "It is but a decent respect due to the wisdom, the integrity, and the patriotism of the legislative body by which any law is passed to presume in favor of its validity until its violation of the Constitution is proved beyond all reasonable doubt." Ogden v. Saunders, 12 Wheat. 213, 25 U. S. 269. MR. JUSTICE CLARKE concurs in this opinion. [Footnote 1] Moody's p. 1544; Commercial and Financial Chronicle, Vol. 94, p. 831; Vol. 98, pp. 1005, 1076. [Footnote 2] Moody's, p. 1548; Commercial and Financial Chronicle, Vol. 94, p. 771; Vol. 96, p. 1428; Vol. 97, p. 1434; Vol. 98, p. 1541. [Footnote 3] Moody's, p. 1547; Commercial and Financial Chronicle, Vol. 97, pp. 1589, 1827, 1903; Vol. 98, pp. 76, 457; Vol. 103, p. 2348. Poor's Manual of Industrials (1918), p. 2240, in giving the "comparative income account" of the company, describes the 1914 dividend as "stock dividend paid (200 percent) -$2,000,000," and describes the 1917 dividend as "$3,000,000 special cash dividend." [Footnote 4] See Some Judicial Myths, by Francis M. Burdick, 22 Harvard Law Review, 393, 394-396; The Firm as a Legal Person, by

William Hamilton Cowles, 57 Cent.L.J. 343, 348; The Separate Estates of Non-Bankrupt Partners, by J. D. Brannan, 20 Harvard Law Review, 589-592. Compare Harvard Law Review, Vol. 7, p. 426; Vol. 14, p. 222; Vol. 17, p. 194. [Footnote 5] The hardship supposed to have resulted from such a decision has been removed in the Revenue Act of 1916 as amended, by providing in 31b that such cash dividends shall thereafter be exempt from taxation if, before they are made, all earnings made since February 28, 1913, shall have been distributed. Act Oct. 3, 1917, c. 63, 1211, 40 Stat. 338, Act Feb. 24, 1919, c. 18, 201(b), 40 Stat. 1059. [Footnote 6] Compare Rugg, C.J., in Tax Commissioner v. Putnam, 227 Mass. 522, 533: "However strong such an argument might be when urged as to the interpretation of a statute, it is not of prevailing force as to the broad considerations involved in the interpretation of an amendment to the Constitution adopted under the conditions preceding and attendant upon the ratification of the forty-fourth amendment." [Footnote 7] Compare Rugg, C.J., Tax Commissioner v. Putnam, 227 Mass. 522, 524: "It is a grant from the sovereign people, and not the exercise of a delegated power. It is a statement of general principles, and not a specification of details. Amendments to such a charter of government ought to be construed in the same spirit and according to the same rules as the original. It is to be interpreted as the Constitution of a state, and not as a statute

or an ordinary piece of legislation. Its words must be given a construction adapted to carry into effect its purpose." [Footnote 8] "It is our duty, when required in the regular course of judicial proceedings, to declare an act of Congress void if not within the legislative power of the United States; but this declaration should never be made except in a clear case. Every possible presumption is in favor of the validity of a statute, and this continues until the contrary is shown beyond a rational doubt. One branch of the government cannot encroach on the domain of another without danger. The safety of our institutions depends in no small degree on a strict observance of this salutary rule." The Sinking Fund Cases, 99 U. S. 700, 99 U. S. 718 (1878). See also Legal Tender Cases, 12 Wall. 457, 79 U. S. 531 (1870); Trade-Mark Cases, 100 U. S. 82, 100 U. S. 96 (1879). See American Doctrine of Constitutional Law by James B. Thayer, 7 Harvard Law Review 129, 142. "With the exception of the extraordinary decree rendered in the Dred Scott case, . . . all of the acts or the portions of the acts of Congress invalidated by the courts before 1868 related to the organization of courts. Denying the power of Congress to make notes legal tender seems to be the first departure from this rule." Haines, American Doctrine of Judicial Supremacy, p. 288. The first legal tender decision was overruled in part two years later (1870), Legal Tender Cases, 12 Wall. 457, and again in 1883, Legal Tender Case, 110 U. S. 421.

Official Supreme Court caselaw is only found in the print version of the United States Reports. Justia caselaw is provided for general informational purposes only, and may not reflect current legal developments, verdicts or settlements. We make no warranties or guarantees about the accuracy, completeness, or adequacy of the information contained on this site or information linked to from this site. Please check official sources [G.R. No. 108576. January 20, 1999] COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. THE COURT OF APPEALS, COURT OF TAX APPEALS and A. SORIANO CORP., respondents. DECISION MARTINEZ, J.: Petitioner Commissioner of Internal Revenue (CIR) seeks the reversal of the decision of the Court of Appeals (CA)[1] which affirmed the ruling of the Court of Tax Appeals (CTA)[2] that private respondent A. Soriano Corporations (hereinafter ANSCOR) redemption and exchange of the stocks of its foreign stockholders cannot be considered as essentially equivalent to a distribution of taxable dividends under Section 83(b) of the 1939 Internal Revenue Act[3] The undisputed facts are as follows: Sometime in the 1930s, Don Andres Soriano, a citizen and resident of the United States, formed the corporation A. Soriano Y Cia, predecessor of ANSCOR, with a P1,000,000.00 capitalization divided into 10,000 common shares at a par value of P100/share. ANSCOR is wholly owned and controlled by the family of Don Andres, who are all non-resident aliens.[4] In 1937, Don Andres subscribed to

4,963 shares of the 5,000 shares originally issued.[5] On September 12, 1945, ANSCORs authorized capital stock was increased to P2,500,000.00 divided into 25,000 common shares with the same par value. Of the additional 15,000 shares, only 10,000 was issued which were all subscribed by Don Andres, after the other stockholders waived in favor of the former their pre-emptive rights to subscribe to the new issues.[6] This increased his subscription to 14,963 common shares.[7] A month later,[8] Don Andres transferred 1,250 shares each to his two sons, Jose and Andres, Jr., as their initial investments in ANSCOR.[9] Both sons are foreigners.[10] By 1947, ANSCOR declared stock dividends. Other stock dividend declarations were made between 1949 and December 20, 1963.[11] On December 30, 1964 Don Andres died. As of that date, the records revealed that he has a total shareholdings of 185,154 shares[12] - 50,495 of which are original issues and the balance of 134,659 shares as stock dividend declarations.[13] Correspondingly, one-half of that shareholdings or 92,577[14] shares were transferred to his wife, Doa Carmen Soriano, as her conjugal share. The other half formed part of his estate.[15] A day after Don Andres died, ANSCOR increased its capital stock to P20M[16] and in 1966 further increased it to P30M.[17] In the same year (December 1966), stock dividends worth 46,290 and 46,287 shares were respectively received by the Don Andres estate[18] and Doa Carmen from ANSCOR. Hence, increasing their accumulated shareholdings to 138,867 and 138,864[19] common shares each.[20] On December 28, 1967, Doa Carmen requested a ruling from the United States Internal Revenue Service (IRS), inquiring if an exchange of common with preferred shares may be

considered as a tax avoidance scheme[21] under Section 367 of the 1954 U.S. Revenue Act.[22] By January 2, 1968, ANSCOR reclassified its existing 300,000 common shares into 150,000 common and 150,000 preferred shares.[23] In a letter-reply dated February 1968, the IRS opined that the exchange is only a recapitalization scheme and not tax avoidance.[24] Consequently,[25] on March 31, 1968 Doa Carmen exchanged her whole 138,864 common shares for 138,860 of the newly reclassified preferred shares. The estate of Don Andres in turn, exchanged 11,140 of its common shares for the remaining 11,140 preferred shares, thus reducing its (the estate) common shares to 127,727.[26] On June 30, 1968, pursuant to a Board Resolution, ANSCOR redeemed 28,000 common shares from the Don Andres estate. By November 1968, the Board further increased ANSCORs capital stock to P75M divided into 150,000 preferred shares and 600,000 common shares.[27] About a year later, ANSCOR again redeemed 80,000 common shares from the Don Andres estate,[28] further reducing the latters common shareholdings to 19,727. As stated in the board Resolutions, ANSCORs business purpose for both redemptions of stocks is to partially retire said stocks as treasury shares in order to reduce the companys foreign exchange remittances in case cash dividends are declared.[29] In 1973, after examining ANSCORs books of account and records, Revenue examiners issued a report proposing that ANSCOR be assessed for deficiency withholding tax-atsource, pursuant to Sections 53 and 54 of the 1939 Revenue Code,[30] for the year 1968 and the second quarter of 1969 based on the transactions of exchange and redemption of stocks.[31] The Bureau of Internal Revenue (BIR) made the

corresponding assessments despite the claim of ANSCOR that it availed of the tax amnesty under Presidential Decree (P.D.) 23[32] which were amended by P.D.s 67 and 157.[33] However, petitioner ruled that the invoked decrees do not cover Sections 53 and 54 in relation to Article 83(b) of the 1939 Revenue Act under which ANSCOR was assessed.[34] ANSCORs subsequent protest on the assessments was denied in 1983 by petitioner.[35] Subsequently, ANSCOR filed a petition for review with the CTA assailing the tax assessments on the redemptions and exchange of stocks. In its decision, the Tax Court reversed petitioners ruling, after finding sufficient evidence to overcome the prima facie correctness of the questioned assessments.[36] In a petition for review, the CA, as mentioned, affirmed the ruling of the CTA.[37] Hence, this petition. The bone of contention is the interpretation and application of Section 83(b) of the 1939 Revenue Act[38] which provides: Sec. 83. Distribution of dividends or assets by corporations. (b) Stock dividends A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manneras to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Italics supplied). Specifically, the issue is whether ANSCORs redemption of

stocks from its stockholder as well as the exchange of common with preferred shares can be considered as essentially equivalent to the distribution of taxable dividend, making the proceeds thereof taxable under the provisions of the above-quoted law. Petitioner contends that the exchange transaction is tantamount to cancellation under Section 83(b) making the proceeds thereof taxable. It also argues that the said Section applies to stock dividends which is the bulk of stocks that ANSCOR redeemed. Further, petitioner claims that under the net effect test, the estate of Don Andres gained from the redemption. Accordingly, it was the duty of ANSCOR to withhold the tax-at-source arising from the two transactions, pursuant to Section 53 and 54 of the 1939 Revenue Act.[39] ANSCOR, however, avers that it has no duty to withhold any tax either from the Don Andres estate or from Doa Carmen based on the two transactions, because the same were done for legitimate business purposes which are (a) to reduce its foreign exchange remittances in the event the company would declare cash dividends,[40] and to (b) subsequently filipinized ownership of ANSCOR, as allegedly envisioned by Don Andres.[41] It likewise invoked the amnesty provisions of P.D. 67. We must emphasize that the application of Sec. 83(b) depends on the special factual circumstances of each case.[42] The findings of facts of a special court (CTA) exercising particular expertise on the subject of tax, generally binds this Court,[43] considering that it is substantially similar to the findings of the CA which is the final arbiter of questions of facts.[44] The issue in this case does not only deal with facts but whether the law applies to a particular set of facts. Moreover, this Court is not necessarily bound by the lower

courts conclusions of law drawn from such facts.[45] AMNESTY: We will deal first with the issue of tax amnesty. Section 1 of P.D. 67[46] provides: I. In all cases of voluntary disclosures of previously untaxed income and/or wealth such as earnings, receipts, gifts, bequests or any other acquisitions from any source whatsoever which are taxable under the National Internal Revenue Code, as amended, realized here or abroad by any taxpayer, natural or juridical; the collection of all internal revenue taxes including the increments or penalties or account of non-payment as well as all civil, criminal or administrative liabilities arising from or incident to such disclosures under the National Internal Revenue Code, the Revised Penal Code, the Anti-Graft and Corrupt Practices Act, the Revised Administrative Code, the Civil Service laws and regulations, laws and regulations on Immigration and Deportation, or any other applicable law or proclamation, are hereby condoned and, in lieu thereof, a tax of ten (10%) per centum on such previously untaxed income or wealth is hereby imposed, subject to the following conditions: (conditions omitted) [Emphasis supplied]. The decree condones the collection of all internal revenue taxes including the increments or penalties or account of nonpayment as well as all civil, criminal or administrative liabilities arising from or incident to (voluntary) disclosures under the NIRC of previously untaxed income and/or wealth realized here or abroad by any taxpayer, natural or juridical. May the withholding agent, in such capacity, be deemed a taxpayer for it to avail of the amnesty? An income taxpayer covers all persons who derive taxable income.[47] ANSCOR

was assessed by petitioner for deficiency withholding tax under Section 53 and 54 of the 1939 Code. As such, it is being held liable in its capacity as a withholding agent and not in its personality as a taxpayer. In the operation of the withholding tax system, the withholding agent is the payor, a separate entity acting no more than an agent of the government for the collection of the tax[48] in order to ensure its payments;[49] the payer is the taxpayer he is the person subject to tax impose by law;[50] and the payee is the taxing authority.[51] In other words, the withholding agent is merely a tax collector, not a taxpayer. Under the withholding system, however, the agent-payor becomes a payee by fiction of law. His (agent) liability is direct and independent from the taxpayer,[52] because the income tax is still impose on and due from the latter. The agent is not liable for the tax as no wealth flowed into him he earned no income. The Tax Code only makes the agent personally liable for the tax[53] (c) 1939 Tax Code, as amended by R.A. No. 2343 which provides in part that xxx Every such person is made personally liable for such tax xxx.53 arising from the breach of its legal duty to withhold as distinguish from its duty to pay tax since: the governments cause of action against the withholding agent is not for the collection of income tax, but for the enforcement of the withholding provision of Section 53 of the Tax Code, compliance with which is imposed on the withholding agent and not upon the taxpayer.[54] Not being a taxpayer, a withholding agent, like ANSCOR in this transaction, is not protected by the amnesty under the decree. Codal provisions on withholding tax are mandatory and must be complied with by the withholding agent.[55] The taxpayer

should not answer for the non-performance by the withholding agent of its legal duty to withhold unless there is collusion or bad faith. The former could not be deemed to have evaded the tax had the withholding agent performed its duty. This could be the situation for which the amnesty decree was intended. Thus, to curtail tax evasion and give tax evaders a chance to reform,[56] it was deemed administratively feasible to grant tax amnesty in certain instances. In addition, a tax amnesty, much like a tax exemption, is never favored nor presumed in law and if granted by a statute, the terms of the amnesty like that of a tax exemption must be construed strictly against the taxpayer and liberally in favor of the taxing authority.[57] The rule on strictissimi juris equally applies.[58] So that, any doubt in the application of an amnesty law/decree should be resolved in favor of the taxing authority. Furthermore, ANSCORs claim of amnesty cannot prosper. The implementing rules of P.D. 370 which expanded amnesty on previously untaxed income under P.D. 23 is very explicit, to wit: Section 4. Cases not covered by amnesty. The following cases are not covered by the amnesty subject of these regulations: xxx xxx xxx (2) Tax liabilities with or without assessments, on withholding tax at source provided under Sections 53 and 54 of the National Internal Revenue Code, as amended;[59] ANSCOR was assessed under Sections 53 and 54 of the 1939 Tax Code. Thus, by specific provision of law, it is not covered by the amnesty. TAX ON STOCK DIVIDENDS

General Rule Section 83(b) of the 1939 NIRC was taken from Section 115(g)(1) of the U.S. Revenue Code of 1928.[60] It laid down the general rule known as the proportionate test[61] wherein stock dividends once issued form part of the capital and, thus, subject to income tax.[62] Specifically, the general rule states that: A stock dividend representing the transfer of surplus to capital account shall not be subject to tax. Having been derived from a foreign law, resort to the jurisprudence of its origin may shed light. Under the US Revenue Code, this provision originally referred to stock dividends only, without any exception. Stock dividends, strictly speaking, represent capital and do not constitute income to its recipient.[63] So that the mere issuance thereof is not yet subject to income tax[64] as they are nothing but an enrichment through increase in value of capital investment.[65] As capital, the stock dividends postpone the realization of profits because the fund represented by the new stock has been transferred from surplus to capital and no longer available for actual distribution.[66] Income in tax law is an amount of money coming to a person within a specified time, whether as payment for services, interest, or profit from investment.[67] It means cash or its equivalent.[68] It is gain derived and severed from capital,[69] from labor or from both combined[70] - so that to tax a stock dividend would be to tax a capital increase rather than the income.[71] In a loose sense, stock dividends issued by the corporation, are considered unrealized gain, and cannot be subjected to income tax until that gain has been realized. Before the realization, stock dividends are nothing but a representation of an interest in the corporate properties.[72] As capital, it is not

yet subject to income tax. It should be noted that capital and income are different. Capital is wealth or fund; whereas income is profit or gain or the flow of wealth.[73] The determining factor for the imposition of income tax is whether any gain or profit was derived from a transaction.[74] The Exception However, if a corporation cancels or redeems stock issued as a dividend at such time and in such manner as to make the distribution and cancellation or redemption, in whole or in part, essentially equivalent to the distribution of a taxable dividend, the amount so distributed in redemption or cancellation of the stock shall be considered as taxable income to the extent it represents a distribution of earnings or profits accumulated after March first, nineteen hundred and thirteen. (Emphasis supplied). In a response to the ruling of the American Supreme Court in the case of Eisner v. Macomber[75] (that pro rata stock dividends are not taxable income), the exempting clause above quoted was added because corporations found a loophole in the original provision. They resorted to devious means to circumvent the law and evade the tax. Corporate earnings would be distributed under the guise of its initial capitalization by declaring the stock dividends previously issued and later redeem said dividends by paying cash to the stockholder. This process of issuance-redemption amounts to a distribution of taxable cash dividends which was just delayed so as to escape the tax. It becomes a convenient technical strategy to avoid the effects of taxation. Thus, to plug the loophole the exempting clause was added. It provides that the redemption or cancellation of stock dividends, depending on the time and manner it was made is essentially equivalent to a distribution of taxable dividends,

making the proceeds thereof taxable income to the extent it represents profits. The exception was designed to prevent the issuance and cancellation or redemption of stock dividends, which is fundamentally not taxable, from being made use of as a device for the actual distribution of cash dividends, which is taxable.[76] Thus, the provision had the obvious purpose of preventing a corporation from avoiding dividend tax treatment by distributing earnings to its shareholders in two transactions a pro rata stock dividend followed by a pro rata redemption that would have the same economic consequences as a simple dividend.[77] Although redemption and cancellation are generally considered capital transactions, as such, they are not subject to tax. However, it does not necessarily mean that a shareholder may not realize a taxable gain from such transactions.[78]Simply put, depending on the circumstances, the proceeds of redemption of stock dividends are essentially distribution of cash dividends, which when paid becomes the absolute property of the stockholder. Thereafter, the latter becomes the exclusive owner thereof and can exercise the freedom of choice[79] Having realized gain from that redemption, the income earner cannot escape income tax.[80] As qualified by the phrase such time and in such manner, the exception was not intended to characterize as taxable dividend every distribution of earnings arising from the redemption of stock dividends.[81] So that, whether the amount distributed in the redemption should be treated as the equivalent of a taxable dividend is a question of fact,[82] which is determinable on the basis of the particular facts of the transaction in question.[83] No decisive test can be used to determine the application of the exemption under Section

83(b) The use of the words such manner and essentially equivalent negative any idea that a weighted formula can resolve a crucial issue Should the distribution be treated as taxable dividend.[84] On this aspect, American courts developed certain recognized criteria, which includes the following:[85] 1) the presence or absence of real business purpose, 2) the amount of earnings and profits available for the declaration of a regular dividend and the corporations past record with respect to the declaration of dividends, 3) the effect of the distribution as compared with the declaration of regular dividend, 4) the lapse of time between issuance and redemption,[86] 5) the presence of a substantial surplus[87] and a generous supply of cash which invites suspicion as does a meager policy in relation both to current earnings and accumulated surplus.[88] REDEMPTION AND CANCELLATION For the exempting clause of Section 83(b) to apply, it is indispensable that: (a) there is redemption or cancellation; (b) the transaction involves stock dividends and (c) the time and manner of the transaction makes it essentially equivalent to a distribution of taxable dividends. Of these, the most important is the third. Redemption is repurchase, a reacquisition of stock by a corporation which issued the stock[89] in exchange for property, whether or not the acquired stock is cancelled, retired or held in the treasury.[90] Essentially, the corporation gets back some of its stock, distributes cash or property to the shareholder in payment for the stock, and continues in

business as before. The redemption of stock dividends previously issued is used as a veil for the constructive distribution of cash dividends. In the instant case, there is no dispute that ANSCOR redeemed shares of stocks from a stockholder (Don Andres) twice (28,000 and 80,000 common shares). But where did the shares redeemed come from? If its source is the original capital subscriptions upon establishment of the corporation or from initial capital investment in an existing enterprise, its redemption to the concurrent value of acquisition may not invite the application of Sec. 83(b) under the 1939 Tax Code, as it is not income but a mere return of capital. On the contrary, if the redeemed shares are from stock dividend declarations other than as initial capital investment, the proceeds of the redemption is additional wealth, for it is not merely a return of capital but a gain thereon. It is not the stock dividends but the proceeds of its redemption that may be deemed as taxable dividends. Here, it is undisputed that at the time of the last redemption, the original common shares owned by the estate were only 25,247.5.[91] This means that from the total of 108,000 shares redeemed from the estate, the balance of 82,752.5 (108,000 less 25,247.5) must have come from stock dividends. Besides, in the absence of evidence to the contrary, the Tax Code presumes that every distribution of corporate property, in whole or in part, is made out of corporate profits,[92] such as stock dividends. The capital cannot be distributed in the form of redemption of stock dividends without violating the trust fund doctrine wherein the capital stock, property and other assets of the corporation are regarded as equity in trust for the payment of the corporate creditors.[93] Once capital, it is always capital.[94] That doctrine was intended for the protection of corporate creditors.[95] With respect to the third requisite, ANSCOR redeemed stock

dividends issued just 2 to 3 years earlier. The time alone that lapsed from the issuance to the redemption is not a sufficient indicator to determine taxability. It is a must to consider the factual circumstances as to the manner of both the issuance and the redemption. The time element is a factor to show a device to evade tax and the scheme of cancelling or redeeming the same shares is a method usually adopted to accomplish the end sought.[96] Was this transaction used as a continuing plan, device or artifice to evade payment of tax? It is necessary to determine the net effect of the transaction between the shareholder-income taxpayer and the acquiring (redeeming) corporation.[97] The net effect test is not evidence or testimony to be considered; it is rather an inference to be drawn or a conclusion to be reached.[98] It is also important to know whether the issuance of stock dividends was dictated by legitimate business reasons, the presence of which might negate a tax evasion plan.[99] The issuance of stock dividends and its subsequent redemption must be separate, distinct, and not related, for the redemption to be considered a legitimate tax scheme.[100] Redemption cannot be used as a cloak to distribute corporate earnings.[101] Otherwise, the apparent intention to avoid tax becomes doubtful as the intention to evade becomes manifest. It has been ruled that: [A]n operation with no business or corporate purpose is a mere devise which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to a stockholder.[102] Depending on each case, the exempting provision of Sec.

83(b) of the 1939 Code may not be applicable if the redeemed shares were issued with bona fide business purpose,[103] which is judged after each and every step of the transaction have been considered and the whole transaction does not amount to a tax evasion scheme. ANSCOR invoked two reasons to justify the redemptions (1) the alleged filipinization program and (2) the reduction of foreign exchange remittances in case cash dividends are declared. The Court is not concerned with the wisdom of these purposes but on their relevance to the whole transaction which can be inferred from the outcome thereof. Again, it is the net effect rather than the motives and plans of the taxpayer or his corporation[104] that is the fundamental guide in administering Sec. 83(b). This tax provision is aimed at the result.[105] It also applies even if at the time of the issuance of the stock dividend, there was no intention to redeem it as a means of distributing profit or avoiding tax on dividends.[106] The existence of legitimate business purposes in support of the redemption of stock dividends is immaterial in income taxation. It has no relevance in determining dividend equivalence.[107] Such purposes may be material only upon the issuance of the stock dividends. The test of taxability under the exempting clause, when it provides such time and manner as would make the redemption essentially equivalent to the distribution of a taxable dividend, is whether the redemption resulted into a flow of wealth. If no wealth is realized from the redemption, there may not be a dividend equivalence treatment. In the metaphor of Eisner v. Macomber, income is not deemed realize until the fruit has fallen or been plucked from the tree. The three elements in the imposition of income tax are: (1) there must be gain or profit, (2) that the gain or profit is realized or received, actually or constructively,[108] and (3) it

is not exempted by law or treaty from income tax. Any business purpose as to why or how the income was earned by the taxpayer is not a requirement. Income tax is assessed on income received from any property, activity or service that produces the income because the Tax Code stands as an indifferent neutral party on the matter of where income comes from.[109] As stated above, the test of taxability under the exempting clause of Section 83(b) is, whether income was realized through the redemption of stock dividends. The redemption converts into money the stock dividends which become a realized profit or gain and consequently, the stockholders separate property.[110] Profits derived from the capital invested cannot escape income tax. As realized income, the proceeds of the redeemed stock dividends can be reached by income taxation regardless of the existence of any business purpose for the redemption. Otherwise, to rule that the said proceeds are exempt from income tax when the redemption is supported by legitimate business reasons would defeat the very purpose of imposing tax on income. Such argument would open the door for income earners not to pay tax so long as the person from whom the income was derived has legitimate business reasons. In other words, the payment of tax under the exempting clause of Section 83(b) would be made to depend not on the income of the taxpayer but on the business purposes of a third party (the corporation herein) from whom the income was earned. This is absurd, illogical and impractical considering that the Bureau of Internal Revenue (BIR) would be pestered with instances in determining the legitimacy of business reasons that every income earner may interposed. It is not administratively feasible and cannot therefore be allowed. The ruling in the American cases cited and relied upon by

ANSCOR that the redeemed shares are the equivalent of dividend only if the shares were not issued for genuine business purposes[111] or the redeemed shares have been issued by a corporation bona fide[112] bears no relevance in determining the non-taxability of the proceeds of redemption. ANSCOR, relying heavily and applying said cases, argued that so long as the redemption is supported by valid corporate purposes the proceeds are not subject to tax.[113] The adoption by the courts below [114] of such argument is misleading if not misplaced. A review of the cited American cases shows that the presence or absence of genuine business purposes may be material with respect to the issuance or declaration of stock dividends but not on its subsequent redemption. The issuance and the redemption of stocks are two different transactions. Although the existence of legitimate corporate purposes may justify a corporations acquisition of its own shares under Section 41 of the Corporation Code,[115] such purposes cannot excuse the stockholder from the effects of taxation arising from the redemption. If the issuance of stock dividends is part of a tax evasion plan and thus, without legitimate business reasons the redemption becomes suspicious which may call for the application of the exempting clause. The substance of the whole transaction, not its form, usually controls the tax consequences.[116] The two purposes invoked by ANSCOR under the facts of this case are no excuse for its tax liability. First, the alleged filipinization plan cannot be considered legitimate as it was not implemented until the BIR started making assessments on the proceeds of the redemption. Such corporate plan was not stated in nor supported by any Board Resolution but a mere afterthought interposed by the counsel of ANSCOR. Being a separate entity, the corporation can act only through its Board

of Directors.[117] The Board Resolutions authorizing the redemptions state only one purpose reduction of foreign exchange remittances in case cash dividends are declared. Not even this purpose can be given credence. Records show that despite the existence of enormous corporate profits no cash dividend was ever declared by ANSCOR from 1945 until the BIR started making assessments in the early 1970s. Although a corporation under certain exceptions, has the prerogative when to issue dividends, yet when no cash dividends was issued for about three decades, this circumstance negates the legitimacy of ANSCORs alleged purposes. Moreover, to issue stock dividends is to increase the shareholdings of ANSCORs foreign stockholders contrary to its filipinization plan. This would also increase rather than reduce their need for foreign exchange remittances in case of cash dividend declaration, considering that ANSCOR is a family corporation where the majority shares at the time of redemptions were held by Don Andres foreign heirs. Secondly, assuming arguendo, that those business purposes are legitimate, the same cannot be a valid excuse for the imposition of tax. Otherwise, the taxpayers liability to pay income tax would be made to depend upon a third person who did not earn the income being taxed. Furthermore, even if the said purposes support the redemption and justify the issuance of stock dividends, the same has no bearing whatsoever on the imposition of the tax herein assessed because the proceeds of the redemption are deemed taxable dividends since it was shown that income was generated therefrom. Thirdly, ANSCOR argued that to treat as taxable dividend the proceeds of the redeemed stock dividends would be to impose on such stock an undisclosed lien and would be extremely unfair to intervening purchasers, i.e. those who buys the stock dividends after their issuance.[118] Such argument, however,

bears no relevance in this case as no intervening buyer is involved. And even if there is an intervening buyer, it is necessary to look into the factual milieu of the case if income was realized from the transaction. Again, we reiterate that the dividend equivalence test depends on such time and manner of the transaction and its net effect. The undisclosed lien[119] may be unfair to a subsequent stock buyer who has no capital interest in the company. But the unfairness may not be true to an original subscriber like Don Andres, who holds stock dividends as gains from his investments. The subsequent buyer who buys stock dividends is investing capital. It just so happen that what he bought is stock dividends. The effect of its (stock dividends) redemption from that subsequent buyer is merely to return his capital subscription, which is income if redeemed from the original subscriber. After considering the manner and the circumstances by which the issuance and redemption of stock dividends were made, there is no other conclusion but that the proceeds thereof are essentially considered equivalent to a distribution of taxable dividends. As taxable dividend under Section 83(b), it is part of the entire income subject to tax under Section 22 in relation to Section 21[120] of the 1939 Code. Moreover, under Section 29(a) of said Code, dividends are included in gross income. As income, it is subject to income tax which is required to be withheld at source. The 1997 Tax Code may have altered the situation but it does not change this disposition. EXCHANGE SHARES[121] OF COMMON WITH PREFERRED

considered as a taxable transaction. The exchange of common stocks with preferred stocks, or preferred for common or a combination of either for both, may not produce a recognized gain or loss, so long as the provisions of Section 83(b) is not applicable. This is true in a trade between two (2) persons as well as a trade between a stockholder and a corporation. In general, this trade must be parts of merger, transfer to controlled corporation, corporate acquisitions or corporate reorganizations. No taxable gain or loss may be recognized on exchange of property, stock or securities related to reorganizations.[124] Both the Tax Court and the Court of Appeals found that ANSCOR reclassified its shares into common and preferred, and that parts of the common shares of the Don Andres estate and all of Doa Carmens shares wereexchanged for the whole 150, 000 preferred shares. Thereafter, both the Don Andres estate and Doa Carmen remained as corporate subscribers except that their subscriptions now include preferred shares. There was no change in their proportional interest after the exchange. There was no cash flow. Both stocks had the same par value. Under the facts herein, any difference in their market value would be immaterial at the time of exchange because no income is yet realized it was a mere corporate paper transaction. It would have been different, if the exchange transaction resulted into a flow of wealth, in which case income tax may be imposed.[125] Reclassification of shares does not always bring any substantial alteration in the subscribers proportional interest. But the exchange is different there would be a shifting of the balance of stock features, like priority in dividend declarations or absence of voting rights. Yet neither the reclassification nor exchange per se, yields realize income for tax purposes. A common stock represents the residual ownership interest in

Exchange is an act of taking or giving one thing for another[122] involving reciprocal transfer[123] and is generally

the corporation. It is a basic class of stock ordinarily and usually issued without extraordinary rights or privileges and entitles the shareholder to a pro rata division of profits.[126] Preferred stocks are those which entitle the shareholder to some priority on dividends and asset distribution.[127] Both shares are part of the corporations capital stock. Both stockholders are no different from ordinary investors who take on the same investment risks. Preferred and common shareholders participate in the same venture, willing to share in the profits and losses of the enterprise.[128] Moreover, under the doctrine of equality of shares all stocks issued by the corporation are presumed equal with the same privileges and liabilities, provided that the Articles of Incorporation is silent on such differences.[129] In this case, the exchange of shares, without more, produces no realized income to the subscriber. There is only a modification of the subscribers rights and privileges - which is not a flow of wealth for tax purposes. The issue of taxable dividend may arise only once a subscriber disposes of his entire interest and not when there is still maintenance of proprietary interest.[130] WHEREFORE, premises considered, the decision of the Court of Appeals is MODIFIED in that ANSCORs redemption of 82,752.5 stock dividends is herein considered as essentially equivalent to a distribution of taxable dividends for which it is LIABLE for the withholding tax-at-source. The decision is AFFIRMED in all other respects. SO ORDERED. Davide, Jr., C.J., (Chairman), Melo, Kapunan, and Pardo, JJ., concur.

U.S. Supreme Court Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955) Commissioner v. Glenshaw Glass Co. No. 199 Argued February 28, 1955 Decided March 28, 1955* 348 U.S. 426 CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT Syllabus Money received as exemplary damages for fraud or as the punitive two-thirds portion of a treble damage antitrust recovery must be reported by a taxpayer as "gross income" under 22(a) of the Internal Revenue Code of 1939. Pp. 348 U. S. 427-433. (a) In determining what constitutes "gross income" as defined in 22(a), effect must be given to the catch-all language "gains or profits and income derived from any source whatever." Pp. 348 U. S. 429-430. (b) Eisner v. Macomber, 252 U. S. 189, distinguished. Pp. 348 U. S. 430-431. (c) The mere fact that such payments are extracted from the wrongdoers as punishment for unlawful conduct cannot detract from their character as taxable income to the recipients. P. 348 U. S. 431. (d) A different result is not required by the fact that 22 (a)

was reenacted without change after the Board of Tax Appeals had held punitive damages nontaxable inHighland Farms Corp., 42 B.T.A. 1314. Pp. 348 U. S. 431-432. (e) The legislative history of the Internal Revenue Code of 1954 does not require a different result. The definition of gross income was simplified, but no effect upon its present broad scope was intended. P. 348 U. S. 432. (f) Punitive damages cannot be classified as gifts, nor do they come under any other exemption in the Code. P. 348 U. S. 432. 211 F.2d 928 reversed. Page 348 U. S. 427 MR. CHIEF JUSTICE WARREN delivered the opinion of the Court. This litigation involves two cases with independent factual backgrounds, yet presenting the identical issue. The two cases were consolidated for argument before the Court of Appeals for the Third Circuit, and were heard en banc. The common question is whether money received as exemplary damages for fraud or as the punitive two-thirds portion of a treble damage antitrust recovery must be reported by a taxpayer as gross income under 22(a) of the Internal Revenue Code of 1939. [Footnote 1] In a single opinion, 211 F.2d 928, the Court of Appeals affirmed the Tax Court's separate rulings in favor of the taxpayers. 18 T.C. 860; 19 T.C. 637. Because of the frequent recurrence of the question and differing interpretations by the lower courts of this Court's decisions bearing upon the problem, we granted the Commissioner of Internal Revenue's ensuing petition for certiorari. 348 U.S. 813.

The facts of the cases were largely stipulated, and are not in dispute. So far as pertinent, they are as follows: Commissioner v. Glenshaw Glass Co. -- The Glenshaw Glass Company, a Pennsylvania corporation, manufactures glass bottles and containers. It was engaged in protracted litigation with the Hartford-Empire Company, which manufactures machinery of a character used by Glenshaw. Among the claims advanced by Glenshaw Page 348 U. S. 428 were demands for exemplary damages for fraud [Footnote 2] and treble damages for injury to its business by reason of Hartford's violation of the federal antitrust laws. [Footnote 3] In December, 1947, the parties concluded a settlement of all pending litigation by which Hartford paid Glenshaw approximately $800,000. Through a method of allocation which was approved by the Tax Court, 18 T.C. 860, 870-872, and which is no longer in issue, it was ultimately determined that, of the total settlement, $324,529.94 represented payment of punitive damages for fraud and antitrust violations. Glenshaw did not report this portion of the settlement as income for the tax year involved. The Commissioner determined a deficiency, claiming as taxable the entire sum less only deductible legal fees. As previously noted, the Tax Court and the Court of Appeals upheld the taxpayer. Commissioner v. William Goldman Theatres, Inc. -- William Goldman Theatres, Inc., a Delaware corporation operating motion picture houses in Pennsylvania, sued Loew's, Inc., alleging a violation of the federal antitrust laws and seeking treble damages. After a holding that a violation had occurred, William Goldman Theatres, Inc. v. Loew's Inc.,150 F.2d 738, the case was remanded to the trial court for a determination of damages. It was found that Goldman had

suffered a loss of profits equal to $125,000, and was entitled to treble damages in the sum of $375,000. William Goldman Theatres, Inc. v. Loew's, Inc., 69 F.Supp. 103, aff'd 164 F.2d 1021, cert. denied, 334 U.S. 811. Goldman reported only $125,000 of the recovery as gross income, and claimed that the $250,000 Page 348 U. S. 429 balance constituted punitive damages, and, as such, was not taxable. The Tax Court agreed, 19 T.C. 637, and the Court of Appeals, hearing this with the Glenshaw case, affirmed. 211 F.2d 928. It is conceded by the respondents that there is no constitutional barrier to the imposition of a tax on punitive damages. Our question is one of statutory construction: are these payments comprehended by 22(a)? The sweeping scope of the controverted statute is readily apparent: "SEC. 22. GROSS INCOME." "(a) GENERAL DEFINITION. 'Gross income' includes gains, profits, and income derived from salaries, wages, or compensation for personal service . . . of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. . . ." (Emphasis added.) [Footnote 4] This Court has frequently stated that this language was used

by Congress to exert in this field "the full measure of its taxing power." Helvering v. Clifford, 309 U. S. 331,309 U. S. 334; Helvering v. Midland Mutual Life Ins. Co., 300 U. S. 216, 300 U. S. 223;Douglas v. Willcuts, 296 U. S. 1, 296 U. S. 9; Irwin v. Gavit, 268 U. S. 161, 268 U. S. 166. Respondents contend that punitive damages, characterized as "windfalls" flowing from the culpable conduct of third parties, are not within the scope of the section. But Congress applied no limitations as to the source of taxable receipts, nor restrictive Page 348 U. S. 430 labels as to their nature. And the Court has given a liberal construction to this broad phraseology in recognition of the intention of Congress to tax all gains except those specifically exempted. Commissioner v. Jacobson, 336 U. S. 28, 336 U. S. 49;Helvering v. Stockholms Enskilda Bank, 293 U. S. 84, 293 U. S. 87-91. Thus, the fortuitous gain accruing to a lessor by reason of the forfeiture of a lessee's improvements on the rented property was taxed in Helvering v. Bruun, 309 U. S. 461.Cf. Robertson v. United States, 343 U. S. 711; Rutkin v. United States, 343 U. S. 130;United States v. Kirby Lumber Co., 284 U. S. 1. Such decisions demonstrate that we cannot but ascribe content to the catchall provision of 22(a), "gains or profits and income derived from any source whatever." The importance of that phrase has been to frequently recognized since its first appearance in the Revenue Act of 1913 [Footnote 5] to say now that it adds nothing to the meaning of "gross income." Nor can we accept respondents' contention that a narrower reading of 22(a) is required by the Court's characterization of income in Eisner v. Macomber, 252 U. S. 189, 252 U. S. 207, as "the gain derived from capital, from labor, or from both combined." [Footnote 6] The Court was there endeavoring to

determine whether the distribution of a corporate stock dividend constituted a realized gain to the shareholder, or changed "only the form, not the essence," of Page 348 U. S. 431 his capital investment. Id. at 252 U. S. 210. It was held that the taxpayer had "received nothing out of the company's assets for his separate use and benefit." Id. at 252 U. S. 211. The distribution, therefore, was held not a taxable event. In that context -- distinguishing gain from capital -- the definition served a useful purpose. But it was not meant to provide a touchstone to all future gross income questions. Helvering v. Bruun, supra, at 309 U. S. 468-469; United States v. Kirby Lumber Co., supra, at 284 U. S. 3. Here, we have instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion. The mere fact that the payments were extracted from the wrongdoers as punishment for unlawful conduct cannot detract from their character as taxable income to the recipients. Respondents concede, as they must, that the recoveries are taxable to the extent that they compensate for damages actually incurred. It would be an anomaly that could not be justified in the absence of clear congressional intent to say that a recovery for actual damages is taxable, but not the additional amount extracted as punishment for the same conduct which caused the injury. And we find no such evidence of intent to exempt these payments. It is urged that reenactment of 22(a) without change since the Board of Tax Appeals held punitive damages nontaxable in Highland Farms Corp., 42 B.T.A. 1314, indicates congressional satisfaction with that holding. Reenactment -particularly without the slightest affirmative indication that Congress ever had the Highland Farms decision before it -- is

an unreliable indicium, at best. Helvering v. Wilshire Oil Co., 308 U. S. 90,308 U. S. 100-101; Koshland v. Helvering, 298 U. S. 441, 298 U. S. 447. Moreover, the Commissioner promptly published his nonacquiescence in this portion of theHighland Farms holding, [Footnote 7] and has, Page 348 U. S. 432 before and since, consistently maintained the position that these receipts are taxable. [Footnote 8] It therefore cannot be said with certitude that Congress intended to carve an exception out of 22(a)'s pervasive coverage. Nor does the 1954 Code's [Footnote 9] legislative history, with its reiteration of the proposition that statutory gross income is "all-inclusive," [Footnote 10] give support to respondents' position. The definition of gross income has been simplified, but no effect upon its present broad scope was intended. [Footnote 11] Certainly punitive damages cannot reasonably be classified as gifts, cf. Commissioner v. Jacobson, 336 U. S. 28, 336 U. S. 47-52, nor do they come under any other exemption provision in the Code. We would do violence to the plain meaning of the statute and restrict a clear legislative attempt to Page 348 U. S. 433 bring the taxing power to bear upon all receipts constitutionally taxable were we to say that the payments in question here are not gross income. See Helvering v. Midland Mutual Life Ins. Co., supra, at 300 U. S. 223. Reversed. MR. JUSTICE DOUGLAS dissents. MR. JUSTICE HARLAN took no part in the consideration or decision of this case. * Together with Commissioner of Internal Revenue v. William

Goldman Theaters, Inc.,which was a separate case decided by the Court of Appeals in the same opinion. [Footnote 1] 53 Stat. 9, 53 Stat. 574, 26 U.S.C. 22(a). [Footnote 2] For the bases of Glenshaw's claim for damages from fraud, see Shawkee Manufacturing Co. v. Hartford-Empire Co., 322 U. S. 271; Hazel-Atlas Glass Co. v. Hartford-Empire Co., 322 U. S. 238. [Footnote 3] See Hartford-Empire Co. v. United States, 323 U. S. 386, 324 U. S. 324 U.S. 570. [Footnote 4] See note 1 supra. [Footnote 5] 38 Stat. 114, 167. [Footnote 6] The phrase was derived from Stratton's Independence, Ltd. v. Howbert, 231 U. S. 399,231 U. S. 415, and Doyle v. Mitchell Bros. Co., 247 U. S. 179, 247 U. S. 185, two cases construing the Revenue Act of 1909, 36 Stat. 11, 112. Both taxpayers were "wasting asset" corporations, one being engaged in mining, the other in lumbering operations. The definition was applied by the Court to demonstrate a distinction between a return on capital and "a mere conversion of capital assets." Doyle v. Mitchell Bros. Co., supra, at 247 U. S. 184. The question raised by the instant case is clearly distinguishable.

[Footnote 7] 1941-1 Cum.Bull, 16. [Footnote 8] The long history of departmental rulings holding personal injury recoveries nontaxable on the theory that they roughly correspond to a return of capital cannot support exemption of punitive damages following injury to property. See 2 Cum.Bull. 71; I-1 Cum.Bull. 92, 93; VII-2 Cum.Bull. 123; 1954-1 Cum.Bull. 179, 180. Damages for personal injury are, by definition, compensatory only. Punitive damages, on the other hand, cannot be considered a restoration of capital for taxation purposes. [Footnote 9] 68A Stat. 3 et seq. Section 61(a) of the Internal Revenue Code of 1954, 68A Stat. 17, is the successor to 22(a) of the 1939 Code. [Footnote 10] H.R.Rep.No.1337, 83d Cong., 2d Sess. A18; S.Rep.No.1622, 83d Cong., 2d Sess. 168. [Footnote 11] In discussing 61(a) of the 1954 Code, the House Report states: "This section corresponds to section 22(a) of the 1939 Code. While the language in existing section 22(a) has been simplified, the all-inclusive nature of statutory gross income has not been affected thereby. Section 61(a) is as broad in scope as section 22(a)." "Section 61(a) provides that gross income includes 'all income

from whatever source derived.' This definition is based upon the 16th Amendment, and the word 'income' is used in its constitutional sense." H.R.Rep.No.1337, supra, note 10 at A18 A virtually identical statement S.Rep.No.1622, supra, note 10 at 168. appears in

Syllabus from pages 716-718 intentionally omitted Messrs. Arthur A. Ballantine and George E. Cleary, both of New York City, for Old Colony Trust Co. and others. The Attorney General and Mr. Alfred A. Wheat, of Washington, D. C., for Commissioner of Internal Revenue. TOP Mr. Chief Justice TAFT delivered the opinion of the Court.

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We have before us for consideration two questions certified from the same Circuit Court of Appeals, No. 130 and No. 129. They are presented upon different statements of facts, and the cases reach the certifying court in different ways, but the questions are so nearly alike that the certifying judges deemed it convenient to present them in consolidated form. We prefer to separate the questions, discuss and decide No. 130 first, and then consider No. 129. No. 130 comes here by certificate from the Circuit Court of Appeals for the First Circuit. The action in that court was begun by a petition to review a decision of the United States Board of Tax Appeals. The petitioners are the executors of the will of William M. Wood, deceased. On June 27, 1925, before Mr. Wood's death, the Commissioner of Internal Revenue notified him by registered mail of the determination of a deficiency in income tax against him for the years 1919 and 1920, under the Revenue Act of 1918 ( 40 Stat. 1057). The deficiency was revised by the Commissioner August 18, 1925. An appeal was taken to the Board of Tax Appeals, which was filed October 27, 1925. A hearing before the Board, April 11, 1927, resulted in a decision November 12, 1927. The Board approved the action of the Commissioner, and found a

OLD COLONY TRUST CO. et al. v. COMMISSIONER OF INTERNAL REVENUE. 279 U.S. 716 (49 S.Ct. 499, 73 L.Ed. 918) OLD COLONY TRUST CO. et al. v. COMMISSIONER OF INTERNAL REVENUE. No. 130. Reargued: April 15, 1929. Decided: June 3, 1929. Opinion, TAFT [HTML]

deficiency in the federal income tax return of Mr. Wood for the year 1919 of $708,781.93, and for the year 1920 of $350,837.14. The petition for review was perfected December 23, 1927, pursuant to the Revenue Act of 1926, 283(j), and sections 1001 to 1005, c. 27, 44 Stat. 9, 65, 109; 26 USCA 1064(j), and 1224-1228, and rule 38 of the First Circuit Court of Appeals. The facts certified to us are substantially as follows: William M. Wood was president of the American Woolen Company during the years 1918, 1919, and 1920. In 1918 he received as salary and commissions from the company $978,725, which he included in his federal income tax return for 1918. In 1919 he received as salary and commissions from the company $548,132.87, which he included in his return for 1919. August 3, 1916, the American Woolen Company had adopted the following resolution, which was in effect in 1919 and 1920: 'Voted: That this company pay any and all income taxes, State and Federal, that may hereafter become due and payable upon the salaries of all the officers of the company, including the president, William M. Wood; the comptroller, Parry C. Wiggin; the auditor, George R. Lawton; and the following members of the staff, to wit: Frank H. Carpenter, Edwin L. Heath, Samuel R. Haines, and William M. Lasbury, to the end that said persons and officers shall receive their salaries or other compensation in full without deduction on account of income taxes, State or Federal, which taxes are to be paid out of the treasury of this corporation.' This resolution was amended on March 25, 1918, as follows: 'Voted: That, referring to the vote passed by this board on August 3, 1916, in reference to income taxes, State and

Federal, payable upon the salaries or compensation of the officers and certain employees of this company, the method of computing said taxes shall be as follows, viz.: "The difference between what the total amount of his tax would be, including his income from all sources, and the amount of his tax when computed upon his income excluding such compensation or salaries paid by this company." Pursuant to these resolutions, the American Woolen Company paid to the collector of internal revenue Mr. Wood's federal income and surtaxes due to salary and commissions paid him by the company, as follows: The decision of the Board of Tax Appeals here sought to be reviewed was that the income taxes of $681,169.88 and $351,179.27 paid by the American Woolen Company for Mr. Wood were additional income to him for the years 1919 and 1920. The question certified by the Circuit Court of Appeals for answer by this Court is: 'Did the payment by the employer of the income taxes assessable against the employee constitute additional taxable income to such employee?' The first point presented to us is that of the jurisdiction of this Court to answer the question of law certified. It requires us to examine the original statute providing for the Board of Tax Appeals under the Revenue Act of 1924, and the amending act of 1926. The Board of Tax Appeals, established by section 900 of the Revenue Act of 1924, tit. 9, c. 243, 43 Stat. 253, 336 (26 USCA 1211, note, et seq.), was created by Congress to provide taxpayers an opportunity to secure an independent

review of the Commissioner of Internal Revenue's determination of additional income and estate taxes by the Board in advance of their paying the tax found by the Commissioner to be due. Before the act of 1924, the taxpayer could only contest the Commissioner's determination of the amount of the tax after its payment. The Board's duty under the act of 1924 was to hear, consider, and decide whether deficiencies reported by the Commissioner were right. Section 273 of that act (26 USCA 1047) defined a 'deficiency' to be the amount by which the tax imposed exceeded the amount shown by the return of the taxpayer after the return was increased by the amounts previously assessed or disallowed. There was under the act of 1924 no direct judicial review of the proceedings before the Board of Tax Appeals. But each party had the unhindered right to seek separate action by a court of competent jurisdiction to test the correctness of the Board's action. Such court proceedings were to be begun within one year after the final decision of the Board. Section 274(b); 26 USCA 1049, note, provided that, if the Board determined there was a deficiency, the amount so determined should be assessed and paid upon notice and demand from the collector. No part of the amount determined as a deficiency by the Commissioner, but disallowed as a deficiency by the Board, could be assessed, but the Commissioner was at liberty, notwithstanding the decision of the Board against him, to bring a suit in a proper court against the taxpayer to collect the alleged deficiency. On the other hand, by section 900(g); 26 USCA 1218, note, it was provided that, in any suit brought by the Commissioner, or by the taxpayer to recover any amounts paid in pursuance of a decision of the Board, the findings of the Board were

prima facie evidence of the facts. By the Revenue Act of 1926, this procedure was changed, and a direct judicial review of the Board's decision was substituted. The act of 1926 also enlarged the original jurisdiction of the Board of Tax Appeals to consider deficiencies beyond those shown in the Commissioner's notice, if the Commissioner made such a claim at or before the hearing (section 274(e); 26 USCA 1048c), and also to determine that the taxpayer not only did not owe the tax but had over paid (section 284(e); 26 USCA 1065, note). The chief change made by the act of 1926 was the provision for direct judicial review of the Board's decisions by the filing by the Commissioner or the taxpayer of a petition for review in a Circuit Court of Appeals or the Court of Appeals of the District of Columbia under rules adopted by such courts. It is suggested that the proceedings before the Circuit Courts of Appeals or the District Court of Appeals on a petition to review are and can not be judicial, for they involve 'no case or controversy,' and without this a Circuit Court of Appeals, which is a constitutional court (Ex parte Bakelite Corporation, No. 17, Original, 279 U. S. 438, 49 S. Ct. 411, 73 L. Ed. , decided May 20, 1929) is incapable of exercising its judicial function. This view of the nature of the proceedings we cannot sustain. The case is analogous to the suits which are lodged in the Circuit Courts of Appeals upon petition or finding of an executive or administrative tribunal. It is not important whether such a proceeding was originally begun by an administrative or executive determination, if, when it comes to the court, whether legislative or constitutional, it calls for the exercise of only the judicial power of the court upon which jurisdiction has been conferred by law. The jurisdiction in this cause is quite

like that of Circuit Courts of Appeals in review of orders of the Federal Trade Commission. Federal Trade Commission v. Eastman Kodak Co., 274 U. S. 623, 47 S. Ct. 688, 71 L. Ed. 1238; Silver Co. v. Federal Trade Commission (C. C. A.) 292 F. 752. There are other instances of a like kind which can be cited. United States v. Ritchie, 17 How. 525, 534, 15 L. Ed. 236; Interstate Commerce Commission v. Brimson, 154 U. S. 447, 469, 14 S. Ct. 1125, 38 L. Ed. 1047; Stephens v. Cherokee Nation,174 U. S. 445, 477, 19 S. Ct. 722, 43 L. Ed. 1041. See, also, Fong Yue Ting v. United States,149 U. S. 698, 714, 13 S. Ct. 1016, 37 L. Ed. 905. It is not necessary that the proceeding to be judicial should be one entirely de novo. It is enough that, before the judgment which must be final has been invoked as an exercise of judicial power, it shall have certain necessary features. What these are has been often declared by this Court. Perhaps the most comprehensive definitions of them are set forth in Muskrat v. United States, 219 U. S. 346, 356, 31 S. Ct. 250, 55 L. Ed. 246, where this Court entered into the inquiry what was the exercise of judicial power as conferred by the Constitution. There was cited there a definition by Mr. Justice Field in Re Pacific Railway Commission (C. C.) 32 F. 241, 255, which has been generally accepted as accurate. He said: 'The judicial article of the Constitution mentions cases and controversies. The term 'controversies,' if distinguishable at all from 'cases,' is so in that it is less comprehensive than the latter, and includes only suits of a civil nature. Chisholm v. Georgia, 2 Dall. 431, 432, (1 L. Ed. 440); 1 Tuck. Bl. Comm. App. 420, 421. By cases and controversies are intended the claims of litigants brought before the courts for determination by such regular proceedings as are established by law or custom for the protection or enforcement of rights, or the prevention, redress, or punishment of wrongs. Whenever the

claim of a party under the Constitution, laws, or treaties of the United States takes such a form that the judicial power is capable of acting upon it, then it has become a case. The term implies the existence of present or possible adverse parties whose contentions are submitted to the court for adjudication.' In Osborn v. United States Bank, 9 Wheat. 738, page 819, 6 L. Ed. 204, Chief Justice Marshall construed article 3 of the Constitution as follows: 'This clause enables the judicial department to receive jurisdiction to the full extent of the constitution, laws and treaties of the United States, when any question respecting them shall assume such a form that the judicial power is capable of acting on it. That power is capable of acting only when the subject is submitted to it, by a party who asserts his rights in the form prescribed by law. It then becomes a case, and the constitution declares, that the judicial power shall extend to all cases arising under the constitution, laws and treaties of the United States.' The Circuit Court of Appeals is a constitutional court under the definition of such courts as given in the Bakelite Case, supra, and a case or controversy may come before it, provided it involves neither advisory nor executive action by it. In the case we have here, there are adverse parties. The United States or its authorized official asserts its right to the the payment by a taxpayer of a tax due from him to the government, and the taxpayer is resisting that payment or is seeking to recover what he has already paid as taxes when by law they were not properly due. That makes a case or controversy, and the proper disposition of it is the exercise of judicial power. The courts are either the Circuit Court of Appeals or the District of Columbia Court of Appeals. The subject-matter of the controversy is the amount of the tax

claimed to be due or refundable and its validity, and the judgment to be rendered is a judicial judgment. The Board of Tax Appeals is not a court. It is an executive or administrative board, upon the decision of which the parties are given an opportunity to base a petition for review to the courts after the administrative inquiry of the Board has been had and decided. It is next suggested that there is no adequate finality provided in respect to the action of these courts. In the first place, it is not necessary, in order to constitute a judicial judgment, that there should be both a determination of the rights of the litigants and also power to issue formal execution to carry the judgment into effect, in the way that judgments for money or for the possession of land usually are enforced. A judgment is sometimes regarded as properly enforceable through the executive departments instead of through an award of execution by this Court, where the effect of the judgment is to establish the duty of the department to enforce it. La Abra Silver Mining Co. v. United States, 175 U. S. 423, 457, 461, 20 S. Ct. 168, 44 L. Ed. 223. The case of Fidelity National Bank & Trust Co. v. Swope, 274 U. S. 123, 132, 47 S. Ct. 511, 71 L. Ed. 959, shows clearly that there are instances where the award of execution is not an indispensable element of a constitutional case or controversy. In that decision there are collected familiar examples of judicial proceedings resulting in a final adjudication of the rights of litigants without it. But, even if a formal execution be required, we think power to resort to it is clearly shown with respect to the enforcement of the action of the courts here involved by sections 1001 to 1005. By the first, the decision of the Board of Tax Appeals rendered after the passage of the act of 1926 may be reviewed by the

Circuit Court of Appeals or the District Court of Appeals, if a petition for such review is filed either by the Commissioner or the taxpayer within six months after the decision is rendered. The courts are to adopt rules for the filing of the petition, the preparation of the record, and the conduct of the proceedings upon such review. The review is not to operate as a stay of assessment or collection of any portion of the amount of the deficiency determined by the Board, unless a petition for review is filed by the taxpayer, or unless the taxpayer has filed a bond which when enforced will operate finally to settle the rights of the parties as found by the courts. By section 1002 (26 USCA 1225), it is provided in what venue the decision may be reviewed. In section 1003 (26 USCA 1226), the Circuit Courts of Appeals and the Court of Appeals of the District are given exclusive jurisdiction to review the decisions of the Board, and it is declared that their judgments shall be final, except that they shall be subject to review by the Supreme Court of the United States, on certificate or by certiorari in the manner provided in section 240 of the Judicial Code as amended (28 USCA 347), and in such review the courts shall have the power to affirm, or, if the decision of the Board is not in accordance with law, to modify or reverse the decision of the Board, with or without remanding the case for a rehearing, as justice may require. By section 1004 (26 USCA 1227), the same courts are given power to impose damages in any case where the decision of the Board is affirmed, and it appears that the petition was filed merely for delay. By section 1005 (26 USCA 1228), the decision of the Board is to become final in respect to all the numerous instances which in the course of the review may naturally end further litigation. In the provisions of these sections, the legislation

prescribes minute details for the enforcement of the judgments that are the result of these petitions for review in the several courts vested with jurisdiction over them. The complete purpose of Congress to provide a final adjudication in such proceedings, binding all the parties, is manifest, and demonstrates the unsoundness of the objection. We have before us, however, for actual inquiry a case different from one just considered in the regular course of a petition for review of a decision of the Board, begun and decided all after the enactment of the act of 1926. It is one in which the appeal to the Board of Tax Appeals had been taken, but the appeal had not been decided by the Board before the passage of the act of 1926. That presents what involves a troublesome exception or duplication in the procedure. This occurs because of the last excepting clause of section 283(b) of the amending act of 1926 (26 USCA 1064(b), which is as follows: 'If before the enactment of this Act any person has appealed to the Board of Tax Appeals under subdivision (a) of Section 274 of the Revenue Act of 1924 * * * and the appeal is pending before the Board at the time of the enactment of this Act, the Board shall have jurisdiction of the appeal. In all such cases the powers, duties, rights, and privileges of the Commissioner and of the person who has brought the appeal, and the jurisdiction of the Board and of the courts, shall be determined, and the computation of the tax shall be made, in the same manner as provided in subdivision (a) of this section, except as provided in subdivision (j) of this section and except that the person liable for the tax shall not be subject to the provisions of subdivision (d) of Section 284.' The provisions of section 284(d); 26 USCA 1065(d) are those which deny to the taxpayer the power to bring any suit for the recovery of the tax after he has adopted the procedure

of appealing to the Board of Tax Appeals or to the Circuit Court of Appeals. By this last exception in 283(b), there seems still open to the taxpayers who have filed a petition under the law of 1924 and have not had a decision by the Board before the enactment of the law of 1926, the right to pay the tax and sue for a refund in the proper District Court (paragraph 20 of section 24 of the Judicial Code, as amended by section 1310(c), c. 136, 42 Stat. 311, U. S. Code, title 28, 41; 28 USCA 41(20). Emery v. United States (D. C.) 27 F.(2d) 992, and Old Colony R. Co. v. United States (D. C.) 27 F.(2d) 994, hold that the petitioner still retains this earlier remedy. The truth seems to be that, in making provision to render conclusive judgments on petitions for review in the Circuit Courts of Appeals, Congress was not willing in cases where the Board of Tax Appeals had not decided the issue before the passage of the act of 1926 to cut off the taxpayer from paying the tax and suing for a refund in the proper District Court. But the apparent conflict in such cases can be easily resolved by the use of the principles of res judicata. If both remedies are pursued, the one in a District Court for refund, and the other on a petition for review in the Circuit Court of Appeals, the judgment which is first rendered will then put an end to the questions involved, and in effect make all proceedings in the other court of no avail. Whichever judgment is first in time is necessarily final to the extent to which it becomes a judgment. There is no reason, therefore, in the case before us to decline to take jurisdiction. See Bryar v. Campbell, 177 U. S. 649, 20 S. Ct. 794, 44 L. Ed. 926; Kline v. Burke Construction Co., 260 U. S. 226, 230,43 S. Ct. 79, 67 L. Ed. 226, 24 A. L. R. 1077; Stanton v. Embry, 93 U. S. 548, 554, 23 L. Ed. 983. Second. The jurisdiction here is based upon the certificate of a

question of law. That is whether the payment by the employer of the income taxes assessed against the employee constitutes additional returnable taxable income to such employee. The certification of such a question by the Circuit Court of Appeals is an invocation of the appellate jurisdiction of this Court and therefore within the Constitution. Third. Coming now to the merits of this case, we think the question presented is whether a taxpayer, having induced a third person to pay his income tax or having acquiesced in such payment as made in discharge of an obligation to him, may avoid the making of a return thereof and the payment of a corresponding tax. We think he may not do so. The payment of the tax by the employers was in consideration of the services rendered by the employee, and was again derived by the employee from his labor. The form of the payment is expressly declared to make no difference. Section 213, Revenue Act of 1918, c. 18, 40 Stat. 1065. It is therefore immaterial that the taxes were directly paid over to the government. The discharge by a third person of an obligation to him is equivalent to receipt by the person taxed. The certificate shows that the taxes were imposed upon the employee, that the taxes were actually paid by the employer, and that the employee entered upon his duties in the years in question under the express agreement that his income taxes would be paid by his employer. This is evidenced by the terms of the resolution passed August 3, 1916, more than one year prior to the year in which the taxes were imposed. The taxes were paid upon a valuable consideration, namely, the services rendered by the employee and as part of the compensation therefor. We think, therefore, that the payment constituted income to the employee. This result is sustained by many decisions. Providence & Worcester R. R. Co., 5 B. T. A. 1186; Houston Belt & Terminal

Ry. Co. v. Commissioner, 6 B. T. A. 1364; West End Street Railway Co. v. Malley (C. C. A.) 246 F. 625; Rensselaer & S. R. Co. v. Irwin (C. C. A.) 249 F. 726; Northern R. Co. of New Jersey v. Lowe (C. C. A.) 250 F. 856; Houston Belt & Terminal Ry. Co. v. United States (C. C. A.) 250 F. 1; Blalock v. Georgia Ry. & Electric Co. (C. C. A.) 246 F. 387; Hamilton v. Kentucky & Indiana Terminal R. Co. (C. C. A.) 289 F. 20; American Telegraph & Cable Co. v. United States, 61 Ct. Cl. 326; United States v. Western Union Telegraph Co. (D. C.) 19 F.(2d) 157; Estate of Levalley, 191 Wis. 356, 210 N. W. 941; Estate of Irwin, 196 Cal. for services, even though entirely voluntary, Nor can it be argued that the payment of the tax in No. 130 was a gift. The payment for services, even though entirely yoluntary, was nevertheless compensation within the statute. This is shown by the case of Noel v. Parrott (C. C. A.) 15 F.(2d) 669. There it was resolved that a gratuitous appropriation equal in amount to $3 per share on the outstanding stock of the company be set aside out of the assets for distribution to certain officers and employees of the company, and that the executive committee be authorized to make such distribution as they deemed wise and proper. The executive committee gave $35,000 to be paid to the plaintiff taxpayer. The court said (page 672 of 15 F.(2d)): 'In no view of the evidence, therefore, can the $35,000 be regarded as a gift. It was either compensation for services rendered or a gain or profit derived from the sale of the stock of the corporation, or both; and, in any view, it was taxable as income.' It is next argued against the payment of this tax that, if these payments by the employer constitute income to the employee, the employee will be called upon to pay the tax imposed upon this additional income, and that the payment of the additional

tax will create further income which will in turn be subject to tax, with the result that there would be a tax upon a tax. This, it is urged, is the result of the government's theory, when carried to its logical conclusion, and results in an absurdity which Congress could not have contemplated. In the first place, no attempt has been made by the Treasury to collect further taxes, upon the theory that the payment of the additional taxes creates further income, and the question of a tax upon a tax was not before the Circuit Court of Appeals, and has not been certified to this Court. We can settle questions of that sort when an attempt to impose a tax upon a tax is undertaken, but not now. United States v. Sullivan, 274 U. S. 259, 264, 47 S. Ct. 607, 71 L. Ed. 1037, 51 A. L. R. 1020; Yazoo & Mississippi Valley R. Co. v. Jackson Vinegar Co., 226 U. S. 217, 219, 33 S. Ct. 40, 57 L. Ed. 193. It is not, therefore, necessary to answer the argument based upon an algebraic formula to reach the amount of taxes due. The question in this case is, 'Did the payment by the employer of the income taxes assessable against the employee constitute additional taxable income to such employee?' The answer must be 'Yes.' Separate opinion of Mr. Justice McREYNOLDS. The Board of Tax Appeals belongs to the executive department of the government and performs administrative functions-the assessment of taxes. The statute attempts to grant a broad appeal to the courts, and directs them to reconsider the Board's action-to do or to say what it should have done. This enjoins the use of executive power, not judicial. The duty thus imposed upon the courts is wholly different from that which arises upon the filing of a petition to annul or enforce the action of the Interstate Commerce Commission or the Federal Trade Commission.

I think the Circuit Court of Appeals was without jurisdiction. UNITED STATES v. KIRBY LUMBER CO. 284 U.S. 1 (52 S.Ct. 4, 76 L.Ed. 131) UNITED STATES v. KIRBY LUMBER CO. No. 26. Argued: Oct. 21, 1931. Decided: Nov. 2, 1931. Opinion, HOLMES [HTML] The Attorney General and Mr. Charles B. Rugg, Asst. Atty. Gen., for the United States. Mr. Robert Ash, of Washington, D. C., for respondent. TOP Mr. Justice HOLMES delivered the opinion of the court. In July, 1923, the plaintiff, the Kirby Lumber Company, issued its own bonds for $12,126,800 for which it received their par value. Later in the same year it purchased in the open market some of the same bonds at less than par, the difference of price being $137,521.30. The question is whether this difference is a taxable gain or income of the plaintiff for the year 1923. By the Revenue Act of (November 23) 1921, c. 136, 213(a), 42 Stat. 238, gross income includes 'gains or profits and income derived from any source whatever,' and by the Treasury Regulations authorized by 1303 (26 USCA 1245), that have been in force through repeated reenactments, 'If the corporation purchases and retires any of such bonds at a price less than the issuing price or face value,

the excess of the issuing price or face value over the purchase price is gain or income for the taxable year.' Article 545(1)(c) of Regulations 62, under Revenue Act of 1921. See Article 544(1)(c) of Regulations 45, under Revenue Act of 1918; Article 545(1)(c) of Regulations 65, under Revenue Act of 1924; Article 545(1)(c) of Regulations 69, under Revenue Act of 1926; Article 68(1) (c) of Regulations 74, under Revenue Act of 1928. We see no reason why the Regulations should not be accepted as a correct statement of the law. In Bowers v. Kerbaugh-Empire Co., 271 U. S. 170, 46 S. Ct. 449, 70 L. Ed. 886, the defendant in error owned the stock of another company that had borrowed money repayable in marks or their equivalent for an enterprise that failed. At the time of payment the marks had fallen in value, which so far as it went was a gain for the defendant in error, and it was contended by the plaintiff in error that the gain was taxable income. But the transaction as a whole was a loss, and the contention was denied. Here there was no shrinkage of assets and the taxpayer made a clear gain. As a result of its dealings it made available $137,521.30 assets previously offset by the obligation of bonds now extinct. We see nothing to be gained by the discussion of judicial definitions. The defendant in error has realized within the year an accession to income, if we take words in their plain popular meaning, as they should be taken here. Burnet v. Sanford & Brooks Co., 282 U. S. 359, 364, 51 S. Ct. 150, 75 L. Ed. 383. Judgment reversed. UNITED STATES v. SULLIVAN. No. 851. Argued: April 27, 1927. Decided: May 16, 1927.

Opinion, HOLMES [HTML] The Attorney General and Mrs. Mabel Walker Willebrandt, Asst. Atty. Gen., for the United States. Argument of Counsel from page 260 intentionally omitted Mr. Frederick W. Aley, of Charleston, S. C., pro hac vice, for respondent. Argument of Counsel from page 261 intentionally omitted TOP Mr. Justice HOLMES delivered the opinion of the Court. The defendant in error was convicted of willfully refusing to make a return of his net income as required by the Revenue Act of 1921, Act Nov. 23, 1921, c. 136, 223(a), 253 ( 42 Stat. 227, 250, 268 (Comp. St. 6336 1/8 kk, 6336 1/8 v)). The judgment was reversed by the Circuit Court of Appeals. Sullivan v. United States, 15 F.(2d) 809. A writ of certiorari was granted by this Court. We may take it that the defendant had sufficient gross income to require a return under the statute unless he was exonerated by the fact that the whole or a large part of it was derived from business in violation of the National Prohibition Act (Comp. St. 10138 1/4 et seq.). The Circuit Court of Appeals held that gains from illicit traffic in liquor were subject to the income tax, but that the Fifth Amendment to the Constitution protected the defendant from the requirement of a return. The Court below was right in holding that the defendant's gains were subject to the tax. By section 213(a), being Comp. St. 6336 1/8 ff, gross income includes 'gains, profits, and income derived from * * * the transaction of any business

carried on for gain or profit, or gains or profits and income derived from any source whatever.' These words are also those of the earlier Act of October 3, 1913, c. 16, section II, B ( 38 Stat. 114, 167), except that the word 'lawful' is omitted before 'business' in the passage just quoted. By section 600 ( 42 Stat. 285 (Comp. St. 5986e)), and by another Act approved on the same day Congress applied other tax laws to this forbidden traffic. Act Nov. 23, 1921, c. 134, 5 ( 42 Stat. 222, 223 (Comp. St. 10138 4/5 c-10138 1/5 e)). United States v. One Ford Coupe , 272 U. S. 321, 327, 47 S. Ct. 154, 47 A. L. R. 1025; 1 United States v. Stafoff, 260 U. S. 477, 480, 43 S. Ct. 197, 67 L. Ed. 358. We see no reason to doubt the interpretation of the Act, or any reason why the fact that a business is unlawful should exempt it from paying the taxes that if lawful it would have to pay. As the defendant's income was taxed, the statute of course required a return. See United States v. Sischo, 262 U. S. 165, 43 S. Ct. 511, 67 L. Ed. 925. In the decision that this was contrary to the Constitution we are of opinion that the protection of the Fifth Amendment was pressed too far. If the form of return provided called for answers that the defendant was privileged from making he could have raised the objection in the return, but could not on that account refuse to make any return at all. We are not called on to decide what, if anything, he might have withheld. Most of the items warranted no compaint. It would be an extreme if not an extravagant application of the Fifth Amendment to say that it authorized a man to refuse to state the amount of his income because it had been made in crime. But if the defendant desired to test that or any other point he should have tested it in the return so that it could be passed upon. He could not draw a conjurer's circle around the whole matter by his own declaration that to write any word upon the government blank would bring him

into danger of the law. Mason v. United States, 244 U. S. 362, 37 S. Ct. 621, 61 L. Ed. 1198; United States ex rel. Vajtauer v. Commissioner of Immigration (January 3, 1927) 273 U. S. 103, 47 S. Ct. 302, 71 L. Ed. 560. In this case the defendant did not even make a declaration, he simply abstained from making a return. See further the decision of the Privy Council, Minister of Finance v. Smith (1927) A. C. 193. It is urged that if a return were made the defendant would be entitled to deduct illegal expenses such as bribery. This by no means follows but it will be time enough to consider the question when a taxpayer has the temerity to raise it. Judgment reversed. CC | Transformed by Public.Resource.Org U.S. Supreme Court North American Oil Consolidated v. Burnet, 286 U.S. 417 (1932) North American Oil Consolidated v. Burnet No. 575 Argued April 20, 21, 1932 Decided May 23, 1932 286 U.S. 417 CERTIORARI TO THE CIRCUIT COURT OF APPEALS FOR THE NINTH CIRCUIT Syllabus 1. Section 13(c) of the Revenue Act of 1916, obliging receivers "operating the property and business of corporations" to make returns of net income "as and for such corporations," applied

only where a receiver was in complete control of the entire properties and business of the corporation; otherwise, the return must be made by the corporation. P. 286 U. S. 422. Page 286 U. S. 418 2. Part of an operating property was taken over by a receiver in a suit challenging the owner's title. Held, that the owner need not report income as of the year when it was collected by the receiver, while the right to it was in doubt, but must report it as income of the year when the amount collected was paid over to him and the bill dismissed. P.286 U. S. 423. 3. The fact that appeals from the decree were not determined in his favor until a later year did not defer the time for returning the income. P. 286 U. S. 424. 50 F.2d 52 affirmed. Certiorari, 284 U.S. 614, to review a judgment reversing a decision of the Board of Tax Appeals, 12 B.T.A. 68. Page 286 U. S. 420 MR. JUSTICE BRANDEIS delivered the opinion of the Court. The question for decision is whether the sum of $171,979.22, received by the North American Oil Consolidated in 1917, was taxable to it as income of that year. The money was paid to the company under the following circumstances: among many properties operated by it in 1916 was a section of oil land the legal title to which stood in the name of the United States. Prior to that year, the government, claiming also the beneficial Page 286 U. S. 421 ownership, had instituted a suit to oust the company from

possession, and on February 2, 1916, it secured the appointment of a receiver to operate the property, or supervise its operations, and to hold the net income thereof. The money paid to the company in 1917 represented the net profits which had been earned from that property in 1916 during the receivership. The money was paid to the receiver as earned. After entry by the district court in 1917 of the final decree dismissing the bill, the money was paid, in that year, by the receiver to the company. United States v. North American Oil Consolidated, 242 F. 723. The government took an appeal (without supersedeas) to the Circuit Court of Appeals. In 1920, that court affirmed the decree. 264 F. 336. In 1922, a further appeal to this Court was dismissed by stipulation. 258 U.S. 633. The income earned from the property in 1916 had been entered on the books of the company as its income. It had not been included in its original return of income for 1916; but it was included in an amended return for that year which was filed in 1918. Upon auditing the company's income and profits tax returns for 1917, the Commissioner of Internal Revenue determined a deficiency based on other items. The company appealed to the Board of Tax Appeals. There, in 1927, the Commissioner prayed that the deficiency already claimed should be increased so as to include a tax on the amount paid by the receiver to the company in 1917. The Board held that the profits were taxable to the receiver as income of 1916, and hence made no finding whether the company's accounts were kept on the cash receipts and disbursements basis or on the accrual basis. 12 B.T.A. 68. The Circuit Court of Appeals held that the profits were taxable to the company as income of 1917, regardless of whether the company's returns were made on the cash or on the Page 286 U. S. 422

accrual basis. 50 F.2d 752. This Court granted a writ of certiorari. 284 U.S. 614. It is conceded that the net profits earned by the property during the receivership constituted income. The company contends that they should have been reported by the receiver for taxation in 1916; that, if not returnable by him, they should have been returned by the company for 1916, because they constitute income of the company accrued in that year, and that, if not taxable as income of the company for 1916, they were taxable to it as income for 1922, since the litigation was not finally terminated in its favor until 1922. First. The income earned in 1916 and impounded by the receiver in that year was not taxable to him, because he was the receiver of only a part of the properties operated by the company. Under 13(c) of the Revenue Act of 1916, * receivers who "are operating the property or business of corporations" were obliged to make returns "of net income as and for such corporations," and "any income tax due" was to be "assessed and collected in the same manner as if assessed directly against the organizations of whose businesses or properties they have custody and control." The phraseology of this section was adopted without change in the Revenue Act of 1918, 40 Stat. 1057, 1081, c. 18, 239. The regulations of the Treasury Department have consistently construed Page 286 U. S. 423 these statutes as applying only to receivers in charge of the entire property or business of a corporation, and in all other cases have required the corporations themselves to report their income. Treas.Regs. 33, arts. 26, 209; Treas.Regs. 45, Arts. 424, 622. That construction is clearly correct. The language of the section contemplates a substitution of the

receiver for the corporation, and there can be such substitution only when the receiver is in complete control of the properties and business of the corporation. Moreover, there is no provision for the consolidation of the return of a receiver of part of a corporation's property or business with the return of the corporation itself. It may not be assumed that Congress intended to require the filing of two separate returns for the same year, each covering only a part of the corporate income without making provision for consolidation so that the tax could be based upon the income as a whole. Second. The net profits were not taxable to the company as income of 1916. For the company was not required in 1916 to report as income an amount which it might never receive. See Burnet v. Logan, 283 U. S. 404, 283 U. S. 413. Compare Lucas v. American Code Co., 280 U. S. 445, 280 U. S. 452; Burnet v. Sanford & Brooks Co.,282 U. S. 359, 282 U. S. 363. There was no constructive receipt of the profits by the company in that year, because at no time during the year was there a right in the company to demand that the receiver pay over the money. Throughout 1916, it was uncertain who would be declared entitled to the profits. It was not until 1917, when the district court entered a final decree vacating the receivership and dismissing the bill, that the company became entitled to receive the money. Nor is it material, for the purposes of this case, whether the company's return was filed on the cash receipts and disbursements basis, or on the accrual basis. In neither event was it taxable in 1916 on Page 286 U. S. 424 account of income which it had not yet received and which it might never receive. Third. The net profits earned by the property in 1916 were not income of the year 1922 -- the year in which the litigation with

the government was finally terminated. They became income of the company in 1917, when it first became entitled to them and when it actually received them. If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent. See Board v. Commissioner, 51 F.2d 73, 75, 76. Compare United States v. S.S. White Dental Mang. Co., 274 U. S. 398, 274 U. S. 403. If in 1922 the government had prevailed, and the company had been obliged to refund the profits received in 1917, it would have been entitled to a deduction from the profits of 1922, not from those of any earlier year.Compare Lucas v. American Code Co., supra. Affirmed. * Act of September 8, 1916, 39 Stat. 756, 771, c. 463: "In cases wherein receivers, trustees in bankruptcy, or assignees are operating the property or business of corporations . . . subject to tax imposed by this title, such receivers, trustees, or assignees shall make returns of net income as and for such corporations . . . in the same manner and form as such organizations are hereinbefore required to make returns, and any income tax due on the basis of such returns made by receivers, trustees, or assignees shall be assessed and collected in the same manner as if assessed directly against the organizations of whose businesses or properties they have custody and control."

COLLECTOR OF INTERNAL REVENUE, petitioner, vs. ARTHUR HENDERSON, respondent. x---------------------------------------------------------x G.R. No. L-13049 vs. COLLECTOR OF INTERNAL REVENUE, respondent. Office of the Solicitor General for petitioner. Formilleza & Latorre for respondent. PADILLA, J.: These are petitioner filed by the Collector of Internal Revenue (G.R. No. L-12954) and by Arthur Henderson (G.R. No. L13049) under the provisions of section 18, Republic Act No. 1125, for review of a judgment dated 26 June 1957 and a resolution dated 28 September 1957 rendered and adopted by the Court of Tax Appeals in Case No. 237. The spouses Artuhur Henderson and Marie B. Henderson (later referred to as the taxpayers) filed with the Bureau of Internal Revenue returns of annual net income for the years 1948 to 1952, inclusive, where the following net incomes, personal exemptions and amounts subject to tax appear: 1948: Net Income ....................................................... P29,573.79 2,500.00 February 28, 1961 ARTHUR HENDERSON, petitioner,

G.R. No. L-12954

February 28, 1961

Less:Personal Exemption ..............................

Amount subject to tax ....................................... 1949: Net Income ....................................................... Less:Personal Exemption .............................. Amount subject to tax ....................................... 1950: Net Income ....................................................... Less:Personal Exemption .............................. Amount subject to tax ....................................... 1951: Net Income ........................................................ Less:Personal Exemption .............................. Amount subject to tax ....................................... 1952: Net Income ....................................................... Less:Personal Exemption .............................. Amount subject to tax .......................................

(Exhibits 1, 3, 5, 7, 9, A, F, J, N, R). In due time the taxpayers P27,073.79 received from the Bureau of Internal Revenue assessment notices Nos. 15804-48, 25450-49, 15255-50, 25705-51 and 22527-52 and paid the amounts assessed as follows: P31,817.66 1948 : 2,500.00 P29,317.66 14 May 1949, O.R. No. 52991, Exhibit B ...... 12 September 1950, O.R. No. 160473, Exhibit B-1 . P34,815.74 1949 3,000.00 : P31,815.74 13 May 1950, O.R. No. 232366, Exhibit G ........... 15 September 1950, O.R. No. 247918, Exhibit G-1 . P32,605.83 3,000.00 1950 : P29,605.83 27 April 1951, O.R. No. 323173, Exhibit K .... 1951 P36,780.11 : 3,000.00 P33,780.11 Total Paid ......................................................... Total Paid .........................................................

P2,0

P4,1

P2,3

P4,6

P7,2

Amount withheld from salary and paid by employer . 15 May 1952, O.R. No. 33250, Exhibit O .................

P5,7

360

15 August 1952, O.R. No. 383318, Exhibit O-1 .... Total Paid ......................................................... 1952 : Amount withheld from salary and paid by employer . 18 May 1953, O.R. No. 438026, Exhibit T .. 13 August 1953, O.R. No. 443483, Exhibit T-1 ..... Total Paid ......................................................... On 28 November 1953, after investigation and verification, the Bureay of Internal Revenue reassessed the taxpayers'income for the years 1948 to 1952, inclusive, as follows: 1948 : Net income per return .................................. Add: Rent expense ........................................................... Additional bonus for 1947 received May 13, 1948 . Other income: Manager's residential expense (2/29/48 a/c/#4.51)

361.20 Manager's residential expense (refer to 1948 P & L) .. P6,502.10 Entrance fee Marikina Gun & Country Club .... Net income per investigation ............................................ Less: Personal exemption ................................................ P5,660.40 Net taxable income .......................................................... 1,160.30 Tax due thereon ............................................................... 1,160.30 Less: Amount of tax already paid per OR #52991 & 160473 P7,981.00 .. Deficiency tax still due & assessable ............................

1949: Net income per return .................................. P29,573.79 Add: disallowances Capital loss (no capital gain) ................... 7,200.00 Undeclared bonus ..................... 6,500.00 Rental allowance from A.I.U. ................... P3,248.84 3,857.75 1,800.00

Subsistence allowance from A.I.U. ... 6,051.30 1,400.00 Net income per investigation ............................................

Less: Personal exemption ................................................. Amount of income subject to tax ................................... Tax due thereon ................................................................ Less: tax already assessed & paid per OR Nos. 232366 & 247918 Deficiency tax due ............................................................. (Should be) ...................................................................... 1951:

2,500.00 43,275.75

Net income per return .................................. P8,292.21 Add: house rental allowance from AIU 4,629.89 Net income per investigation ............................................ P3,662.23 Less: Personal exemption ................................................. 3,662.32 Amount of income subject to tax ....................................

1950 : Net income per return .................................. Add: Rent, electricity, water allowances ......................... Net income per investigation ............................................ Less: Personal exemption ................................................. Net taxable income ............................................................ Tax due thereon ................................................................ Less: tax already paid per OR No. #323173 Deficiency tax due & assessable ...................

Tax due thereon ................................................................ Less: tax already assessed and paid per O.R. Nos. A33250 & 383318 P34,815.74 ....................... Deficiency tax due .................. 8,373.73 1952: P43,189.47

Net income3,000.00 per return .................................. Add: P40,189.47 P10,296.00 Withholding tax ..................................... 7,273.00 Travelling P3,023.00 paid by company

allowances 3

Februayr 1954 and 28 February 1955 stated thegrounds and reasons in support of their request for reconsideration (pp. 36Allowances for rent, telephone, water, electricity, 38, etc. 62-66, BIR rec.). The claimthat as regards the husband7,044.67 ..... taxpayer's allowances forrental and utilities such as water, electricity and telephone,he did not receive the money for said Net income per investigation ............................................ P47,672.18 allowances, but thatthey lieved in the apartment furnished and paid for byhis employer for its convenience; that they had no Less: Personal exemption ................................................. choicebut3,000.00 live in the said apartment furnished by his employer,otherwise they would have lived in a less expensive Net taxable income .................................. P44,672.18 one;that as regards his allowances for rental of P7,200 andresidential expenses of P1,400 and P1,849.32 in 1948, Tax due thereon ................................................................ P12,089.00 rentalof P1,800 and subsistence of P6,051.50 (the latter merelyconsisting of allowances for rent and utilities such as Less: Tax already withheld P5,660.40 light,water, telephone, etc.) in 1949 rental, electricity and waterof P8,373.73 in 1950, rental of P5,782.91 in 1951 and Tax already paid per O.R. rental,telephone, water, electricity, etc. of P7,044.67 in 1952, 2,320.60 7,981.00 Nos. #438026, 443484 onlythe amount of P3,900 for each year, which is the amountthey would have spent for rental of an apartment Deficiency tax still due & collectible ............................... P4,108.00should be taxed; that as regards the amount includingutilities, ofP200 representing entrance fee to the Marikina Gun (Exhibits 2, 4, 6, 8, 10) and demanded payment of andCountry Club paid for him by his employer in 1948, thedeficiency taxes on or before 28 February 1954 with thesame should not be considered as part of their income forit respectto those due for the years 1948, 1949, 1950 and was an expense of his employer and his membershiptherein 1952and on or before 15 February 1954 with respect to was merely incidental to his duties of increasingand sustaining thatdue for the year 1951 (Exhibits B-2, H, L, P, S). the business of his employer; and that asregards the wifetaxpayer's travelling allowance of P3,247.40 in 1952, it should In the foregoing assessments, the Bureau of InternalRevenue not be considered as part of theirincome because she merely considered as part of their taxable income thetaxpayeraccompanied him in his businesstrip to New York as his husband's allowances for rental, residential secretary and, at the behestof her husband's employer, to expenses,subsistence, water, electricity and telephone; study and look into the detailsof the plans and decorations of bonuspaid to him; withholding tax and entrance fee to the the building intendedto be constructed byn his employer in its Marikinagun and Country Bluc paid by his employer for property at DeweyBoulevard. On 15 and 27 February 1954, hisaccount; and travelling allowance of his wife. On 26 and27 the taxpayerspaid the deficiency taxes assessed under Official January 1954 the taxpayers asked for reconsiderationof the ReceiptsNos. 451841, 451842, 451843, 451748 and 451844 foregoing assessment (pp. 29, 31, BIR rec.) andon 11

.......................................................

(ExhibitsC, I, M, Q, and Y). After hearing conducted by theConference Staff of the Bureau of Internal Revenue on5 October 1954 (pp. 74-85, BIR rec.), on 27 May 1955the Staff recommended to the Collector of Internal Revenuethat the assessments made on 28 November 1953 (Exhibits2, 4, 6, 8, 10) be sustained except that the amountof P200 as entrance fee to the Marikina Gun and CountryClub paid for the husband-taxpayer's account by his employerin 1948 should not be considered as part of thetaxpayers' taxable income for that year (pp. 95-107, BIRrec.). On 14 July 1955, in line with the recommendationof the Conference Staff, the Collector of Internal Revenuedenied the taxpayers' request for reconsideration, exceptas regards the assessment of their income tax due for theyear 1948, which was modified as follows: Net income per return Add: Rent expense P29,573.79 7,200.00

Tax due thereon Less; Amount already paid Deficiency tax still due

P 8,506.47 4,136.23 P 4,370.24

Additional bonus for 1947 received on May 6,500.00 13, 1948 Manager's residential expense (2/29/48 a/c 1,400.00 #4.41) Manager's residential expense (1948 profit and loss) Net income per investigation Less: Personal exemption Net taxable income 1,849.32 P46,523.11 2,500.00 P44,023.11

and demanded payment of the deficiency taxes of P4,370.24for 1948, P3,662.23 for 1949, P3,023 for 1950, P2,058 for1951 and P4,108 for 1952, 5% surcharge and 1% monthlyinterest thereon from 1 March 1954 to the date of paymentand P80 as administrative penalty for late payment,to the City Treasurer of Manila not later than 31 July1955 (Exhibit 14). On 30 January 1956 the taxpayersagain sought a reconsideration of the denial of their requestfor reconsideration and offered to settle the case ona more equitable basis by increasing the amount of thetaxable portion of the husbandtaxpayer's allowances forrental, etc. from P3,000 yearly to P4,800 yearly, which "isthe value to the employee of the benefits he derived therefrommeasured by what he had saved on account thereof'in the ordinary course of his life ... for which hewould have spent in any case'". The taxpayers also reiteratedtheir previous stand regarding the transportationallowance of the wife-taxpayer of P3,247.40 in 1952 andrequested the refund of the amounts of P3,477.18, P569.33,P1,294, P354 and P2,164, or a total of P7,858.51, (Exhibit Z). On 10 February 1956 the taxpayers again requestedthe Collector of Internal Revenue to refund to them theamounts allegedly paid in excess as income taxes for theyears 1948 to 1952, inclusive (Exhibit Z-1). The Collectorof Internal Revenue did not take any action on the taxpayers'request for refund. On 15 February 1956 the taxpayers filed in the Courtof Tax Appeals a petition to review the decision of theCollector of

Internal Revenue (C.T.A. Case No. 237). Afterhearing, on 26 June 1957 the Court rendered judgmentholding "that the inherent nature of petitioner's(the husband-taxpayer) employment as president of theAmerican International Underwriters as president of theAmerican International Underwriters of the Philippines,Inc. does not require him to occupy the apartments suppliedby his employer-corporation;" that, however, onlythe amount of P4,800 annually, the ratable value to him ofthe quarters furnished constitutes a part of taxable income;that since the taxpayers did not receive any benefitout of the P3,247.40 traveling expense allowance grantedin 1952 to the wife-taxpayer and that she merely undertookthe trip abroad at the behest of her husband's employer,the same could not be considered as income; andthat even if it were considered as such, still it could not besubject to tax because it was deductible as travel expense;and ordering the Collector of Internal Revenue to refundto the taxpayers the amount of P5,109.33 with interestfrom 27 February 1954, without pronouncement as tocosts. The taxpayers filed a motion for reconsiderationclaiming that the amount of P5,986.61 is the amount refundableto them because the amounts of P1,400 and P1,849.32 as manager's residential expenses in 1948 shouldnot be included in their taxable net income for the reasonthat they are of the same nature as the rentals for theapartment, they being mainly expenses for utilities aslight, water and telephone in the apartment furnished bythe husbant-taxpayer's employer. The Collector of InternalRevenue filed an opposition to their motion for reconsideration.He also filed a separate motion for reconsiderationof the decision claiming that his assessmentunder review was correct and should have been affirmed.The taxpayers filed an opposition to this motion for reconsiderationof the Collector of Internal Revenue; thelatter,

a reply thereto. On 28 September 1957 the Courtdenied both motions for reconsideration. On 7 October1957 the Collector of Internal Revenue filed a notice ofappeal in the Court of Tax Appeals and on 21 October1957, within the extension of time previously granted bythis Court, a petition for review (G.R. No. L-12954). On29 October 1957 the taxpayers filed a notice of appealin the Court of Tax Appeals and a petition for review inthis Court (G.R. No. L-13049). The Collector of Internal Revenue had assigned the followingerrors allegedly committed by the Court of TaxAppeals: I. The Court of Tax Appeals erred in finding that theherein respondent did not have any choice in the selection ofthe living quarters occupied by him. II. The Court of Tax Appeals erred in not consideringthe fact that respondent is not a minor company official butthe President of his employer-corporation, in the appreciationof respondent's alleged lack of choice in the matter of the selectionof the quarters occupied by him. III. The Court of Tax Appeals erred in giving full weightand credence to respondent's allegation, a self-serving and unsupported declaration that the ratable value to him of the living quarters and subsistence allowance was only P400.00 a month. IV. The Court of Tax Appeals erred in holding that only the ratable value of P4,800.00 per annum, or P400.00 a month constitutes income to respondent. V. The Court of Tax Appeals erred in arbitrarily fixing the amount of P4,800.00 per annum, or P400.00 a month as the only amount taxable aganst respondent during the five tax years in question.

VI. The Court of Tax Appeals erred in not finding that travelling allowance in the amount of P3,247.40 constituted income to respondent and, therefore, subject to the income tax. VII. The Court of Tax Appeals erred in ordering the refund of the sum of P5,109.33 with interest from February 17, 1954. (G.R. No. L-12954.) The taxpayers have assigned the following errors allegedly committed by the Court of Tax Appeals: I. The Court of Tax Appeals erred in its computation of the 1948 income tax and consequently in the amount that should be refunded for that year. II. The Court of Tax Appeals erred in denying our motion for reconsideration as contained in its resolution dated September 28, 1957. (G.R. No. L-13049.) The Government's appeal: The Collector of Internal Revenue raises questions of fact. He claims that the evidence is not sufficient to support the findings and conclusion of the Court of Tax Appeals that the quarters occupied by the taxpayers were not of their choice but that of the husband-taxpayer's employer; that it did not take into consideration the fact that the husband-taxpayer is not a mere minor company official, but the highest executive of his employer-corporation; and that the wife-taxpayer's trip abroad in 1952 was not, as found by the Court, a business but a vacation trip. In Collector of Internal Revenue vs. Aznar, 56, Off. Gaz. 2386, this Court held that in petitions for review under section 18, Republic Act No. 1125, it may review the findings of fact of the Court of Tax Appeals. The determination of the main issue in the case requires a review of the evidence. Are the allowances for rental of the

apartment furnished by the husband-taxpayer's employercorporation, including utilities such as light, water, telephone, etc. and the allowance for travel expenses given by his employer-corporation to his wife in 1952 part of taxable income? Section 29, Commonwealth Act No. 466, National Internal Revenue Code, provides: "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rents dividend, securities, or the transaction of any business carried on for gain or profit, or gains, profits, and income derived from any source whatever. (Emphasis ours.) The Court of Tax Appeals found that the husband-taxpayer "is the president of the American International Underwriters for the Philippines, Inc., a domestic corporation engaged in insurance business;" that the taxpayers "entertained officials, guests and customers of his employer-corporation, in apartments furnished by the latter and successively occupied by him as president thereof; that "In 1952, petitioner's wife, Mrs. Marie Henderson, upon request o Mr. C. V. Starr, chairman of the parent corporation of the American International Underwriters for the Philippines, Inc., undertook a trip to New York in connection with the purchase of a lot in Dewey Boulevardby petitioner's employer-corporatio, the construction of a building thereon, the drawing of prospectus and plans for said building, and other related matters." Arthur H. Henderson testified that he is the President of American International Underwriters for the Philippines, Inc., which representa a group of American insurance companies

engagad in the business of general insurance except life insurance; that he receives a basic annual salary of P30,000 and allowance for house rental and utilities like light, water, telephone, etc.; that he and his wife are childless and are the only two in the family; that during the years 1948 to 1952, they lived in apartments chosen by his employer; that from 1948 to the early part of 1950, they lived at the Embassy Apartments on Dakota Street, Manila, where they had a large sala, three bedrooms, dining room, two bathrooms, kitchen and a large porch, and from the early part of 1950 to 1952, they lived at the Rosaria Apartments on the same street where they had a kitchen, sala, dining room two bedrooms and bathroom; that despite the fact that they were the only two in the family, they had to live in apartments of the size beyond their personal needs because as president of the corporation, he and his wife had to entertain and put up houseguests; that during all those years of 1948 to 1952, inclusive, they entertained and put up houseguests of his company's officials, guests and customers such as the president of C, V. Starr & Company, Inc., who spent four weeks in his apartment, Thomas Cocklin, a lawyer from Washington, D.C., and Manuel Elizalde, a stockholder of AIUPI; that were he not required by his employer to live in those apartments furnished to him, he and his wife would have chosen an apartment only large enough for them and spend from P300 to P400 monthly for rental; that of the allowances granted to him, only the amount of P4,800 annually, the maximum they would have spent for rental, should be considered as taxable income and the excess treated as expense of the company; and that the trip to New York undertaken by his wife in 1952, for which she was granted by his employer-corporation travelling expense allowance of P3,247.40, was made at the behest of his employer to assist its architect in the preparation of the plans for a proposed building in Manila and procurement of supplies and materials

for its use, hence the said amount should not be considered as part of taxable income. In support of his claim, letters written by his wife while in New York concerning the proposed building, inquiring about the progress made in the acquisition of the lot, and informing him of the wishes of Mr. C. V. Starr, chairman of the board of directors of the parent-corporation (Exhibits U-1, U-1-A, V, V-1 and W) and a letter written by the witness to Mr. C. V. Starr concerning the proposed building (Exhibits X, X-1) were presented in evidence. Mrs. Marie Henderson testified that for almost three years, she and her husband gave parties every Friday night at their apartment for about 18 to 20 people; that their guests were officials of her husband's employer-corporation and other corporations; that during those parties movies for the entertainment of the guests were shown after dinner; that they also entertained during luncheons and breakfasts; that these involved and necessitated the services of additional servants; and that in 1952 she was asked by Mr. C. V. Starr to come to New York to take up problems concerning the proposed building and entertainment because her husband could not make the trip himself, and because "the woman of the family is closer to those problems." The evidence presented at the hearing of the case substantially supports the findings of the Court of Tax Appeals. The taxpayers are childless and are the only two in the family. The quarters, therefore, that they occupied at the Embassy Apartments consisting of a large sala, three bedrooms, dining room, two bathrooms, kitchen and a large porch, and at the Rosaria Apartments consisting of a kitchen, sala dining room, two bedrooms and a bathroom, exceeded their personal needs. But the exigencies of the husband-taxpayer's high executive position, not to mention social standing, demanded and compelled them to live in amore spacious and pretentious

quarters like the ones they had occupied. Although entertaining and putting up houseguests and guests of the husbnad-taxpayer's employer-corporation were not his predominand occupation as president, yet he and his wife had to entertain and put up houseguests in their apartments. That is why his employer-corporation had to grant him allowances for rental and utilities in addition to his annual basic salary to take care of those extra expenses for rental and utilities in excess of their personal needs. Hence, the fact that the taxpayers had to live or did not have to live in the apartments chosen by the husband-taxpayer's employer-corporation is of no moment, for no part of the allowances in question redounded to their personal benefit or was retained by them. Their bills for rental and utilities were paid directly by the employer-corporation to the creditors (Exhibit AA to DDD, inclusive; pp. 104, 170-193, t.s.n.). Neverthelss, as correctly held by the Court of Tax Appeals, the taxpayers are entitled only to a ratable value of the allowances in question, and only the amount of P4,800 annually, the reasonable amount they would have spent for house rental and utilities such as light, water, telephone, etc., should be the amount subject to tax, and the excess considered as expenses of the corporation. Likewise, the findings of the Court of Tax Appeals that the wife-taxpayer had to make the trip to New York at the behest of her husband's employer-corporation to help in drawing up the plans and specificatins of a proposed building, is also supported by the evidence. The parts of the letters written by the wife-taxpayer to her husband while in New York and the letter written by the husband-taxpayer to Mr. C. V. Starr support the said findings (Exhibits U-2, V-1, W-1, X). No part of the allowance for travellking expenses redounded to the benefit of the taxpayers. Neither was a part thereof retained by them. The fact that she had herself operated on for tumors

while in New York wsa but incidental to her stay there and she must have merely taken advantage of her presence in that city to undergo the operation. The taxpayers' appeal: The taxpayers claim that the Court of Tax Appeals erred in considering the amounts of P1,400 and P1,849.32, or a total of P3,249.32, for "manager's residential expense" in 1948 as taxable income despite the fact "that they were of the same nature as the rentals for the apartment, they being expenses for utilities, such as light, water and telephone necessarily incidental to the apartment furnished to him by his employer." Mrs. Crescencia Perez Ramos, an examiner of the Bureau of Internal Revenue who examined the books of accound of the American International Underwriters for the Philippines, Inc., testified that he total amount of P3,249.32 was reflected in its books as "living expenses of Mr. and Mrs. Arthur Henderson in the quarters they occupied in 1948;" and that "the amount of P1,400 was included as manager's residential expense while the amount of P1,849.32 was entered as profit and loss account." Buenaventura Loberiza, acting head of the accouting department of the American International Underwriters for the Philippines, Inc., testified that rentals, utilities, water, telephone and electric bills of executives of the corporation were entered in the books of account as "subsistence allowances and expenses;" that there was a separate account for salaries and wages of employees and officers; and that expenses for rentals and other utilities were not charged to salary accounts. The taxpayers' claim is supported by the evidence. The total amount of P3,249.32 "for manager's residential expense" in 1948 should be treated as rentals for apartments and utilities

and should not form part of the ratable value subject to tax. The computation made by the taxpayers is correct. Adding to the amount of P29,573.79, their net income per return, the amount of P6,500, the bonus received in 1948, and P4,800, the taxable ratable value of the allowances, brings up their gross income to P40,873.79. Deducting therefrom the amount of P2,500 for personal exemption, the amount of P38,373.79 is the amount subject to income tax. The income tax due on this amount is P6,957.19 only. Deducting the amount of income tax due, P6,957.19, from the amount already paid, P8,562.47 (Exhibits B, B-1, C), the amount of P1,605.28 is the amount refundable to the taxpayers. Add this amount to P563.33, P1,294.00, P354.00 and P2,154.00, refundable to the taxpayers for 1949, 1950, 1951 and 1952 and the total is P5,986.61. The judgment under review is modified as above indicated. The Collector of Internal Revenue is ordered to refund to the taxpayers the sum of P5,986.61, without pronouncement as to costs. Bengzon, Actg. C.J., Bautista Angelo, Labrador, Concepcion, Reyes, J.B.L., Barrera, Paredes and Dizon, JJ.,concur