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profits. It represents the investment of surplus or capital or both.

Method of accounting for stock dividends held not to be taxable.—Regulations 33, 1918, were issued before the decision in the Towne case was handed down. Article 106 provided that all dividends paid by a corporation from earnings accrued since March 1, 1913, were taxable. After the Towne decision was rendered the Treasury revised the regulations as to stock dividends and ruled that all stock dividends declared prior to January 1, 1916, were not taxable, but that if payable thereafter and not applicable to earnings accrued prior to March 1, 1913, such stock dividends were taxable in the same manner as cash dividends.

REGULATION. As stock dividends were taxable income under the Revenue Act of 1916, as well as the present statute, but were not under the Act of October 3, 1913, different considerations may apply to the sale of stock received as a dividend before 1916 and stock so received thereafter. .... For the purpose of ascertaining the gain or loss derived from the sale of stock of a corporation received as a dividend, or from the sale of the stock in respect of which such dividend was paid, the cost (used to include also, where required, fair market price or yalue as of March 1, 1913) of such stock is to be determined in accordance with the following rules:

(1) In the case of stock (a) received as a dividend in 1913, 1914 or 1915 out of surplus however created, or (b) received as a dividend in 1916 or subsequent years out of surplus other than earnings or profits accumulated since February 28, 1913, the cost of each share of new stock is the quotient of the cost of the old stock divided by the number of old and new shares added together.

(2) In the case of the stock in respect of which any stock dividend was paid as described under (1), the cost of each share of old stock is similarly the quotient of the cost of the old stock divided by the number of old and new shares.

(3) In the case of stock received as a dividend in 1916 or subsequent years out of earnings or profits accumulated since February 28, 1913, the cost of each share of new stock is the quotient of the sum of (a) the cost of the old stock plus (b) the valuation at which the new stock was returnable as income (as shown by the transfer of surplus to capital account on the books of the corporation, usually its par value), divided by the number of old and new shares added together.

(4) In the case of the stock in respect of which any stock dividend was paid as described under (3), the cost of each share of old stock is similarly the quotient of the sum of (a) the cost of the old stock plus (b) the valuation at which the new stock was returnable as income, divided by the number of old and new shares.15 (Art. 1547.)

Profit or loss on stock dividend when sold.-If stock dividends were received in 1916 or subsequent years out of earnings or profits accumulated since February 28, 1913, they would be accounted for as follows:

A taxpayer holds 100 shares which cost him $80 per share...$ 8,000.00 In 1919 he receives a stock dividend of 100 shares at par.. 10,000.00

and pays the tax thereon.

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In 1919 sales were made at $110 per share-profit to be reported $20 per share.16

Comments on regulations. Proceeds of the sale of stock dividends declared between March 1, 1913, and December 31, 1915, out of the earnings realized between March 1, 1913, and December 31, 1915 (provided the tax assessed has been refunded), should be entered as dividends received up to the par value of the stock, in order to receive the benefit of the credit for the normal tax. The excess, if any, above par value,

18[Former Procedure]

REGULATION. “.... 3. In the case of stock received as a dividend in 1916 or subsequent years out of surplus earnings or profits accrued since March 1, 1913, the cost of each share is the valuation at which it was returnable as income, as shown by the transfer of surplus to capital account on the books of the corporation, usually its par value.

4. In the case of the stock in respect of which any stock dividend was paid as described under 3, cost of each share is its original cost, regardless of any stock dividend.” (T. D. 2734, June 17, 1918.)

1[Former Procedure] Under T. D. 2734, June 17, 1918, the profit to be reported was: 1. If sales were made from old stock the cost of each share was

assumed to be $80 per share. If sales were made from new stock the cost of each share was

assumed to be $100 per share.

2.

less the cost as ascertained by using the formula in the regulation, constitutes a profit and is taxable as such.

If the profit is not sufficient to permit this method, one should enter the proceeds, up to the par value of the shares, as a dividend and claim credit as a realized loss for the difference between cost and the total price realized, less the amount entered as a dividend. This works out as follows: Cost on July 1, 1913 (new corporation) of 100 shares

$10,000.00 Stock dividend, in 1915, 100 shares (taxed but tax refunded)

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As the corporation charged the 1915 dividend to its surplus account and paid the normal income tax thereon as the earnings were realized during 1913 to 1915 and credited to surplus, the stockholder's holdings as to $50 per share on 200 shares or $100 per share on 100 shares are free from normal tax. 1 Therefore the taxpayer would in this case enter the entire profit of $5,000 as a dividend received.

Again :
Cost on July 1, 1913, of 100 shares

$10,000.00 Stock dividend in 1915,

100 shares

17

Total shares.....

200

Total cost

$10,000.00

"If it were possible to apply profits or dividends to the years when earned or accrued, the credit for normal tax would be at the rate in force during such prior year. If not possible it would seem to be necessary to claim credit for the rate of normal tax in force during the year of sale.

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The corporation has paid the normal tax on $10,000. In order to secure the benefit thereof the taxpayer must enter in his 1919 return a dividend18 of $10,000 and take credit for a loss of $8,000, thus accounting for realized net income of $2,000, which will be subject to the surtax. If the taxpayer were merely to return the $2,000 as a profit the entire credit for the normal tax paid on $10,000 would be lost.

It is clear that the recipient of a stock dividend when being taxed on the proceeds thereof is entitled to the benefit of the normal tax which the corporation has already paid on the earnings since March 1, 1913. The regulations must eventually conform to this principle.

VS.

Stock dividends paid before December 31, 1915, not taxable.

THE TOWNE CASE.—The final interpretation of every tax question rests with the United States Supreme Court. Its opinion upon the subject of stock dividends is of enough importance to warrant the citation of the case in full. Henry R. Towne, Plaintiff in Error, In error to the District

Court of the United Mark Eisner, Collector of United States for the South

States Revenue for the Third District ern District of New
of the State of New York.

York.
Mr. Justice Holmes delivered the opinion of the court.19

This is a suit to recover the amount of a tax paid under duress in respect of a stock dividend alleged by the government to be income. A demurrer to the declaration was sustained by the district court and

"It is, of course, not a dividend in a technical sense, but the returns are not flexible enough to permit its entry in any other way. The transaction should be explained on the return.

245 U. S. 418.

19

judgment was entered for the defendant. 242 Fed. Rep. 702. The facts alleged are that the corporation voted on December 17, 1913, to transfer $1,500,000 surplus, being profits earned before January 1, 1913, to its capital account, and to issue fifteen thousand shares of stock representing the same to its stockholders of record on December 26; that the distribution took place on January 2, 1914, and that the plaintiff received as his due proportion four thousand and one hundred and seventy-four and a half shares. The defendant compelled the plaintiff to pay an income tax upon his stock as equivalent to $417,450 income in cash. The district court held that the stock was income within the meaning of the income tax act of October 3, 1913, c. 16, section II; A, subdivision 1 and 2; and B. 38 Stat. 114, 166, 167. It also held that the act so constructed was constitutional, whereas the declaration set up that so far as the act purported to confer power to make this levy it was unconstitutional and void.

The government in the first place moved to dismiss the case for want of jurisdiction, on the ground that the only question here is the construction of the statute, not its constitutionality. It argues that if such a stock dividend is not income within the meaning of the constitution, it is not income within the intent of the statute, and hence that the meaning of the sixteenth amendment is not an immediate issue, and is important only as throwing light on the construction of the act. But it is not necessarily true that income means the same thing in the constitution and the act. A word is not a crystal, transparent and unchanged; it is the skin of a living thought and may vary greatly in color and content according to the circumstances and the time in which it is used. Lamar v. United States, 240 U. S. 60, 65. Whatever the meaning of the constitution, the government had applied its force to the plaintiff, on the assertion that the statute authorized it to do so, before the suit was brought, and the court below has sanctioned its course. The plaintiff says that the statute as it is construed and administered is unconstitutional. He is not to be defeated by the reply that the government does not adhere to the construction by virtue of which alone it has taken and keeps the plaintiff's money, if this court should think that the construction would make the act unconstitutional. While it keeps the money it opens the question whether the act construed as it has construed it can be maintained. The motion to dismiss is overruled. Billings v. United States, 232 U. S. 261, 276. B. Altman Company v. United States, 224 U. S. 583, 596, 597.

The case being properly stated here, however, the construction of the act is open, as well as its constitutionality if construed as the government has construed it by its conduct. Billings v. United States, ubi supra. Notwithstanding the thoughtful discussion that the case received below we can not doubt that the dividend was capital

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