amendment in the Towne case 76 referred to above, wherein it was held that stock dividends were not taxable under the 1913 Law, but expressly recognized that the word income may have different meanings, as used in the Statute and the Constitution.77 On the other hand, it has been argued that the Supreme Court was not construing the 1913 Law in the Towne case, but was considering the broad question whether or not a stock dividend is fundamentally and essentially income within the meaning of that term as used in the Sixteenth Amendment; in other words, whether or not Congress has power under the Constitution to tax stock dividends without apportionment. In support of this argument it is urged that the Supreme Court was obliged to place its decision in the case of Towne v. Eisner upon constitutional grounds because of the Government's contention that under the sweeping language of the 1913 Law, stock dividends must have been considered taxable if they were income, and that a decision that they were not taxable was equivalent to a decision that they were not income. It is also to be noted in this connection that the dividends involved in the Towne case were from profits earned before January 1, 1913. The Supreme Court by a later decision 78 has removed the possibility that its decision in the Towne case was based upon this ground. The view that the decision denied the constitutional right of Congress to levy an income tax upon stock dividends has been adopted in a recent case in a lower federal court, decided under the 1916 Law, which expressly taxed stock dividends. The court in this case decided that the provision of the 1916 Law by 76 Towne v. Eisner, 245 U. S. 418. 77 Letter from Treasury Department to Collectors dated January 10, 1918, I. T. S., 1918, ¶ 2279. 78 Lynch v. Hornby, 247 U. S. 339. In this case the Court held under the 1913 Law that dividends declared and paid in the ordinary course by a corporation to its stockholders after March 1, 1913, whether from current earnings or a surplus accumulated prior to that date, were taxable as income to the stockholders. See also Peabody v. Eisner, 247 U. S. 347; Gulf Oil Corporation v. Lewellyn, 248 U. S. 71; Southern Pacific Co. v. Lowe, 247 U. S. 330. which stock dividends are in terms stated to be income, and to be taxable as such to the same extent as are cash dividends, was unconstitutional because to impose an income tax upon stock dividends is to tax capital or principal, contrary to the requirement that direct taxes be laid by apportionment among the several states according to population.79 Taxpayers against whom a tax is assessed under the 1916 Law and the Revenue Act of 1918 on stock dividends should exercise care in paying the tax under protest and duress in order to protect their rights to recovery.80 Where stock dividends are reported in the return of income, care should be taken that they are segregated from cash dividends and that it be clearly shown either on the return or on a rider attached to the return that the dividend was paid in stock and that the amount is reported not as an admission of liability for tax thereon, but out of courtesy to the Commissioner and in order to avoid the imposition of penalties for an alleged false or fraudulent return. MONEY VALUE OF STOCK DIVIDENDS. The Revenue Act of 1918 provides 81 that dividends paid in stock of the corporation shall be considered income "to the amount of the earnings or profits distributed." The 1916 Law as amended by the 1917 Law, contained a substantially similar provision.82 Prior to this amendment, the 1916 Law provided that a stock dividend should be taxable "to the amount of its cash value." Both phrases were construed to have the same meaning. Under the law and the regulations stock 79 Macomber v. Eisner, (U. S. Dist. Ct., So. Dist. of N. Y.) decided January 23, 1919, I. T. S. 1918, ¶3718. Judge Mayer overruled the demurrer of the Government to the complaint in this case upon the authority of Towne v. Eisner, 245 U. S. 418, and Peabody v. Eisner, 247 U. S. 347. It is understood that the Government will immediately appeal from this decision to the United States Supreme Court. 80 See Chapter 35 on Assessment and Payment of the Tax for the rules respecting payment under protest and duress. 81 Revenue Act of 1918, § 201 (c). 82 Revenue Act of 1916, § 31, as amended by the Revenue Act of dividends received in 1916 and subsequent years are held to be income to the stockholder as though cash equivalent to the par value of the stock had been received as a dividend instead of the stock, unless the par value does not represent the amount of surplus transferred to capital account as a result of the dividend. In the case of shares without par value the value of the stock for the purpose of taxation would be the amount of surplus transferred by the corporation to capital as a result of the dividend. Thus if a corporation declared a dividend of $100,000 from its surplus to be paid in one thousand shares of stock of the corporation the Treasury Department holds that each share received by the stockholders represented the equivalent of $100 of cash. It is immaterial that the market price of the stock so received is greater or less than the amount of surplus represented by the distribution. Income Derived on Sale of Stock Received as Dividend. The question of taxability of stock dividends refers only to its taxability at the time it is received as a dividend. Under the 1913 Law, for example, a taxpayer may unquestionably have received a stock dividend without being sub. ject to any tax at the time of its receipt. If subsequently he sells that stock there seems to be no question but what the amount he receives may represent a profit or loss under the provisions of the law relating to the sale of property. The rules for determining the profit or loss is affected by several considerations. On this subject the Treasury Department has ruled as follows: 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 accrued since March 1, 1913, the cost 83 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. 83 The word "cost" is used to indicate the cost if the stock was purchased on or after March 1, 1913, or the value on that date if purchased prior thereto. 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 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, the cost of each share is its original cost, regardless of any stock dividend.84 Stock Dividends Resulting from Revaluation of Assets. If a corporation has earnings or surplus accumulated since February 28, 1913, any distribution will be deemed to be from such earnings until they have been distributed.85 If a corporation has no earnings or surplus accumulated after February 28, 1913, it may issue a stock dividend to distribute surplus created from the revaluation of capital assets or to represent value placed upon trademarks, good will, etc., and such dividends are not income to the shareholder. When stock received in payment of such a dividend, or stock in respect of which any such dividend was paid, is sold, the cost of each share of stock, whether old or new, for the purpose of ascertaining the gain or loss resulting from its sale, is the quotient of the cost of the old stock, if acquired on or after March 1, 1913, or its fair market price or value as of that date if acquired prior thereto, divided by the number of old and new shares added together. The profit so ascertained from the sale of such stock is income subject to both normal and surtax in the year in which the sale is made.86 84 T. D. 2734; Reg. 33 Rev., Art. 4, as amended by T. D. 2734. See also letter from Treasury Department dated October 30, 1916, I. T. S., 1918, 256. Letter from Treasury Department dated March 24. 1916 I. T. S., 1918, ¶ 257. 85 Letter from Treasury Department dated May 14, 1918; 1918, 3376. 86 T. D. 2734. F. T.-26 I. T. S. CHAPTER 24 INCOME FROM ROYALTIES Under the 1916 Law and prior laws the Treasury Department expressly required that royalties from mines, oil wells, patents, franchises, or other legalized privileges be separately reported by the individual, but not by corporations. No particular rules have been issued with respect to royalties and with respect to income from royalties, except to hold that royalties received by a corporation in accordance with a contract by which it has assigned the patent rights to manufacture machines, etc., are income and should be so accounted for,1 and that royalties paid to a proprietor by those who are allowed to develop or use property or operate under some right belonging to such proprietor are also to be accounted for as income.2 In the case of mines operated by a lessee on a royalty basis, the amount of royalty received by the lessor is income.3 Royalties from Mines. It has been contended that royalties received under mining leases and oil leases are in fact not income but payments of installments on the purchase price of the natural deposit. The nature of such leases has been the subject of some difference of opinion in the courts. It has been held that the leases are such in name only, and are in fact conveyances of the ore body in place as a part of the realty, and that the so-called royalties merely represent payments for so much land and are in 1 Reg. 33 Rev., Art. 113. January 24, 1916; I. T. S. 2 Reg. 33 Rev., Art. 4. 3 T. D. 2152. Letter from Treasury Department dated 1918, ¶ 1262. |