REGULATION.

rebates made to purchasers, whether or not members of the association, in proportion to their purchases may be excluded from gross income in computing the net income subject to tax. Any profits made from non-members and distributed to members in the guise of rebates are, of course, subject to tax. (Reg. 45, Art. 522.)

Dividends in kind.-Article 1570 states that when a partnership distributes its assets in kind and not in cash, the partner realizes no gain or loss until he disposes of the property. No mention is made of "dividends in kind" by corporations.79

A dividend in kind, generally speaking, means a distribution of assets which cannot readily be turned into money, or which the stockholders or directors do not desire to turn into money.

A stock dividend is not a dividend in kind. When a corporation distributes to its stockholders the stock of another company it is a dividend in kind. If the stock so distributed has a fair market value the dividend is taxable. If it does not have a fair market value it is not taxable until realized. There have been some so-called distributions in kind which should be held to be taxable.

A corporation sells its capital assets for cash, invests the proceeds in marketable securities and divides the securities among its stockholders. This is simply a dividend payable in securities and is taxable, even though, technically, it is a dividend in kind.

80

A corporation buys a plot of land and holds it for some years. No sales are made and no fair market price is ascertainable. The corporation dissolves and conveys the land pro rata to its stockholders. This is a distribution in kind and no tax can be imposed until the stockholders dispose of their holdings, in whole or in part.

The foregoing illustrations are clear cases-one im

[Former Procedure] Art. 1566, Reg. 45 (April 17, 1919 edition), provided for distributions in kind by corporations but the provision was eliminated by T. D. 2924 (September 26, 1919).

So See page 723.

mediately taxable and the other not. Between the two there are cases not so easy to decide. Whether or not the dividend is presently taxable depends largely on two factors: (1) When were the assets divided in kind acquired? (2) Is there any fair market value for the assets distributed?

Dividends on stock of federal reserve banks exempt from both normal and surtaxes.-See page 385. It should be noted that the exemption of dividends received by member banks does not extend to dividends paid on the stock of member banks.

Owners of record liable for tax-exception.-Many stocks are owned by others than shareholders of record. In such cases the following regulation is of importance :81

REGULATION. Dividends on stock of domestic corporations or resident foreign corporations are prima facie income of the record owner of the stock, and such record owner will be liable for any additional tax based thereon, unless a disclosure of the actual ownership is made to the Commissioner on Form 1087 which shall show that the record owner is not the actual owner and who the owner is and his address. In all cases where the actual owner is a nonresident alien individual and the record owner is a person in the United States, the record owner will be considered for tax purposes to have the receipt, custody, control, and disposal of the dividend income and will be required to make return for the actual owner, regardless of the amount of the income, and to pay any surtax found by such return to be due. (Art. 405.)

While this regulation is broad enough to cover all cases, form 1087 is apparently designed for use only by non-resident aliens.

Local taxes paid on bank stocks no longer equivalent of dividends. In addition to the cash dividends received from banks, the owners of some bank stocks have local taxes paid for their account by the bank. The amount of such payments

31 See also Chapter XLI.

is deductible by the banks and does not form constructive income to the stockholder.83

RULING. A shareholder of a bank in West Virginia may file with the assessor a claim for exemption from taxation of the stock, which tax is payable by the bank, to the extent of the indebtedness owing by the shareholder on the assessment date. Where the bank pays to the shareholder the amount of the tax which it would have paid for him to the State, such payment is in the nature of an additional dividend to the recipient.

Such an amount may not be deducted from the gross income of the bank under section 234 (a) 3 of the Revenue Act of 1921. . . . . (C. B. I-1, page 11; Digest I. T. 1300.)

Salaries in excess of reasonable or necessary allowances to be treated as dividends.-As to the treatment of amounts ostensibly paid as compensation, the Treasury has issued the following regulation :

REGULATION. . . . (1) In the case of excessive payments by corporations, if such payments correspond or bear a close relationship to stock holdings, the amount of the excess should be treated as dividends and would thus be exempt from the normal tax in the hands of the recipients. (Art. 106.)

Before the foregoing regulation can be applied, salaries must be found to be excessive. See Chapter XXI.

Dividends paid to resident citizens of China by corporation created by China Trade Act.

LAW. Section 213.

include the following .

"gross income"

(b) does not

which shall be exempt from taxation

under this title [income tax]:...

(13) In the case of an individual, amounts distributed as dividends to or for his benefit by a corporation organized under the China Trade Act, 1922, if, at the time of such distribution, he is a citizen of China resident therein and the equitable right to the income of the shares of stock of the corporation is in good faith vested in him.84

82 Section 234 (a-3).

83 Section 214 (a-3-d).

[Former Procedure] Under the 1918 and prior laws, taxes assessed on stockholdings and paid by banks on behalf of their stockholders, were considered as additional dividends to such stockholders, the latter in turn entering the taxes as a deduction in their personal returns.

84 This paragraph was added to the 1921 law by section 26 of the China Trade Act, approved September 19, 1922.

CHAPTER XXVIII

INCOME FROM STOCK DIVIDENDS

In 1920 the Supreme Court of the United States decided finally that stock dividends are not taxable as income.1 Since the imposition of the federal income tax in 1913, the author had consistently predicted that the Supreme Court would take this position.

There are those who still believe that a benefit accrues to the recipient of a stock dividend. Such people show an utter disregard of the market quotations for stocks before and after stock dividends are declared. In most cases the old shares freely sell higher than the new shares, including the dividend. However, the feeling exists that some sort of a legal tax should be imposed and corporations are on notice that what could not be done directly may be done indirectly. In at least two states stock dividends have been held to be taxable income.2

Those who are interested in the various laws, regulations, rulings and court decisions which preceded the handing down of the decision in the Macomber case in 1920 will find them discussed in detail in Income Tax Procedure, 1917 to 1920, both inclusive.

Procedure of current interest includes the definition of a stock dividend, the computation of gain or loss upon the sale of the old or new stock and the method employed in obtaining credit for or refund of the tax collected before the final decision.

1Eisner v. Macomber, 252 U. S. 189, 40 Sup. Ct. 189, 64 L. Ed. 521, March 8, 1920. For full text of decision of court and minority opinion, see Corporation Trust Company 1922 Income Tax Service, supplementary pages 173-186.

2

State ex rel. Dulaney v. Nygaard, 183 N. W. 884, 174 Wisc. 597; Tax Commissioner y. Putnam, 227 Mass. 522, 116 N. E. 904, L. R. A. 1917 F.

806.

The 1921 law contains the following section dealing with stock dividends:

LAW. Section 201.

(d) A stock dividend shall not be subject to tax but if after the distribution of any such dividend the corporation proceeds to cancel or redeem its stock at such time and in such manner as to make the distribution and cancellation or redemption essentially equivalent to the distribution of a taxable dividend, the amount received in redemption or cancellation of the stock shall be treated as a taxable dividend to the extent of the earnings or profits accumulated by such corporation after February 28, 1913.

This section is reasonable. It would be unfortunate if a tax-exempt distribution, the equivalent of cash, could be made indirectly, whereas a direct distribution would be taxable. In providing that the proceeds of redemption of stock dividends shall be treated as dividends instead of as the proceeds of sales of stock, the law now recognizes the principle that the proceeds of the sale or redemption of stock dividends are free from the normal tax, to the extent that the dividend represents a charge against surplus accrued since February 28, 1913.

3*

What Is a Stock Dividend?

A stock dividend is a dividend declared by a corporation payable in stock of the same corporation. Uncertainty regarding stock dividends still exists. Some conceive the term to include a dividend payable in the stock of other corporations which is clearly an erroneous view. Some hold that a dividend on common stock payable in preferred stock is not a true stock dividend. This contention may have some merit, but the author is of the opinion that a dividend payable in any class of stock of the same corporation is not taxable.

3

4

In the case of Loomis v. Wattles, the Circuit Court of

See page 763.

See hearings before the Committee on Ways and Means, House of Representatives, March 18 and 19, 1920, page 38 et seq. The question as to whether a stock dividend can legally be declared in the state of Missouri has been decided in the affirmative. (Č. B. 4, page 24; O. D. 887.)

5

266 Fed. 876.