Amendment; nor can it be contended that the tax in question can be sustained under the act as claimed extension of the amendment, for then, to the extent that the act exceeds the authority of the amendment, it would be unconstitutional under Eisner v. Macomber. The Internal Revenue Commissioner apparently based his decision on the theory that, although in ordinary operations "the borrowing of money and the payment of a loan is a capital transaction, which ordinarily does not result in a taxable gain or deductible loss," nevertheless in this particular transaction the Commissioner held that the rule that borrowing money and repaying loans is a capital transaction is changed, because the bank insisted that, when the plaintiff repaid the loan, it should repay in marks or their equivalent in dollars.

This ruling was based on an attempt to draw an analogy between the transaction of the case at bar and income which a dealer in foreign exchange might have, resultant from the purchase and sale of the currency of a foreign nation. But this plaintiff was not dealing in foreign exchange. It paid its debt in dollars, although, for the purpose of calculating the amount of the settlement, that settlement was based on a rate of exchange in marks. In the case at bar all that plaintiff did was to borrow money from a foreign bank in the currency of the country in which the bank was located, lose that money, and then, eight years later, pay its debt in dollars at the equivalent at the then value of marks. Nothing has been severed from the plaintiff's capital as a result of this transaction which has come in to the plaintiff. The improvement of the plaintiff's balance sheet is not income to the plaintiff. All that it had was a decrease in liability. In Eisner v. Macomber, supra, it was held that "enrichment through increase in value of capital investment is not income in any proper meaning of the term."

In the Smietanka and Phellis cases, the Supreme Court held that, when stock or property are sold, income is realized to the extent of the difference between the value of such stock or property at the time it was purchased and the amount realized on such sale. Those cases follow within the definition of income as given in the Eisner case, because they were based either on sale of capital assets, as in the Smietanka case, or a conversion of capital assets, as in the Phellis case.

There was a

In the case at bar, there was no sale of capital assets, nor was there any such conversion of capital assets, as existed in the Phellis case. On the government's theory, all that the plaintiff could have had is an accretion of assets. As a matter of fact there was not even an increase of assets. decrease of assets through the payment of a part of plaintiff's assets in settling the indebtedness. The fact that after the transaction the plaintiff's balance sheet had improved was not sufficient to constitute "a gain derived from capital." If any thing, it was a gain accruing to capital, and, as such, under the Eisner and Phellis cases, was not taxable income.

If we were to assume that Congress had power to enlarge, as done in section 213 of the Revenue Act of 1921 (Comp. St. Ann. Supp. 1923, § 63361ff), there is nothing in this section that justifies the Internal Revenue Commissioner including this item of $684,456.18 in the gross income, or that an income tax should be based on such item. The pertinent provision of the Revenue Act of 1921 is section 213, which reads as follows:

"That for the purposes of this title (except as otherwise provided in section 233), the term 'gross income'

of

"(a) Includes gains, profits, and income derived from salaries, wages, or compensation for personal service 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."

The provisions of section 213 are obviously broader than the language of the Sixteenth Amendment. The item was not income; that leaves for consideration only the two elements. Was it gain, or was it profit? It seems clear that, under the Revenue Act, the intent was to tax only gains or profits resultant from the employment of capital. We can eliminate the theory that it was a gain or profit, through dealing in foreign exchange. That, then, leaves the proposition. that if, at the end of any taxable year, the balance sheet of a

taxpayer shows a greater difference between assets and liabilities than it did at the end of the preceding taxable year, the excess of difference is taxable as such. However, that leaves out of consideration the essential element to make such a difference taxable income, which is the necessity that it shall be derived from the employment of capital or labor, or from the sale or conversion of capital assets, resulting in a profit from such sale or conversion.

The plaintiff paid a debt in 1921 for a lesser amount in dollars than it had secured through borrowing amounts in marks in 1911, 1912, and 1913. It is equivalent to a release of obligation to that extent. If the debt had been released in full, there could have been no tenable claim made that the plaintiff gained income to the extent of the amount of the debt. For the Circuit Court of Appeals in United States v. Oregon-Washington Railroad & Navigation Co., 251 Fed. 211, 213, 163 C. C. A. 367, 369, held that, where an indebtedness of a corporation was canceled, the amount of the indebtedness so canceled did not and could not constitute in

come.

The Oregon case arose under the Corporation Excise Tax Act (36 Stat. 112), but that act was an excise tax based on the income of the corporation and required a definition of the word "income."

In Southern Pacific Co. v. Lowe, 247 U. S. 330, 38 Sup. Ct. 540, 62 L. ed. 1142, it was held that the word "income,' which was applicable under the Excise Tax Act, will be applied in construing the term "income" under the Income Tax Act. It seems clear that neither the Sixteenth Amendment nor the Revenue Act sought to levy an income tax upon anything except income as it was actually received, and under the Constitution and the Revenue Act of 1921 there can be no such thing as a negative income; the two words being inconsistent.

The defendant's motion for judgment on the pleadings is denied, and a decree may be entered in favor of the plaintiff.15

15 Suppose creditors enter into a composition agreement with a debtor, thereby agreeing to take 50 cents on the dollar. Is there income to the debtor? See I. T. 1547, Cum, Bull. II-1, p. 58; S. M. 1495, Cum. Bull. III-1, p. 108.

Suppose an individual is discharged as a bankrupt. Does he realize taxable income to the extent of his discharged obligations? See I. T. 1564, Cum. Bull. II-1, p. 59.

IV. DIVIDENDS

Revenue Act of 1924.

SEC. 201. (a) The term "dividend" when used in this title (except in paragraph (9) of subdivision (a) of section 234 and paragraph (4) of subdivision (a) of section 245) means any distribution made by a corporation to its shareholders, whether in money or in other property, out of its earnings or profits accumulated after February 28, 1913.

(b) For the purposes of this Act every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits. Any earnings or profits accumulated, or increase in value of property accrued, before March 1, 1913, may be distributed exempt from tax, after the earnings and profits accumulated after February 28, 1913, have been distributed, but any such tax-free distribution shall be applied against and reduce the basis of the stock provided in section 204.

(c) Amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation of a corporation shall be treated as in part or full payment in exchange for the stock. The gain or loss to the distributee resulting from such exchange shall be determined under section 202, but shall be recognized only to the extent provided in section 203. In the case of amounts distributed in partial liquidation (other than a distribution within the provisions of subdivision (g) of section 203 of stock or securities in connection with a reorganization) the part of such distribution which is properly chargeable to capital account shall not be considered a distribution of earnings or profits within the meaning of subdivision (b) of this section for the purpose of determining the taxability of subsequent distributions by the corporation.

(d) If any distribution (not in partial or complete liquidation) made by a corporation to its shareholders is not out of increase in value of property accrued before March 1, 1913, and is not out of earnings or profits, then the amount of such distribution shall be applied against and reduce the basis of the stock provided in section 204, and if in excess of such basis, such excess shall be taxable in the same manner as a gain from the sale or exchange of property. The provisions of this paragraph shall also apply to distributions from depletion reserves based on the discovery value of mines.

(e) Any distribution made by a corporation, which was classified as a personal service corporation under the provisions of the Revenue Act of 1918 or the Revenue Act of 1921, out of its earnings or profits which were taxable in accordance with the provisions of section 218 of the Revenue Act of 1918 or section 218 of the Revenue Act of 1921, shall be exempt from tax to the distributees.

(f) A stock dividend shall not be subject to tax, but if before or 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 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, to the extent that it represents a distribution of earnings or profits accumulated after February 28, 1913, shall be treated as a taxable dividend.

(g) As used in this section the term "amounts distributed in partial liquidation" means a distribution by a corporation in complete cancellation or redemption of a part of its stock, or one of a series of distributions in complete cancellation or redemption of all or a portion of its stock.

Regulations 65.

ART. 1541. Dividends.- Dividends for the purpose of the statute comprise any distribution in the ordinary course of business, even though extraordinary in amount, made by a domestic or foreign corporation to its shareholders out of its earnings or profits accumulated since February 28, 1913. Although interest on state bonds and certain other obligations is not taxable when received by a corporation, upon amalgamation with the other funds of the corporation such income loses its identity and when distributed to shareholders in dividends is taxable to the same extent as other dividends. (See further article 52.)

A taxable distribution made by a corporation to its shareholders shall be included in the gross income of the distributees when the cash or other property is unqualifiedly made subject to their demands. (See article 52.)

ART. 1542. Source of distribution.-For the purpose of income taxation every distribution made by a corporation is made out of earnings or profits to the extent thereof and from the most recently accumulated earnings or profits.

ART. 1543. Distribution out of earnings or profits accumulated prior to March 1, 1913.—Any distribution by a corporation out of earnings or profits accumulated prior to March 1, 1913, or out of increase in value of property accrued prior to March 1, 1913 (whether or not realized by sale or other disposition prior to March 1, 1913), is not a dividend within the meaning of the act. The provisions of the preceding sentence shall be applied uniformly to cases arising under the