Revenue Act of 1916, the Revenue Act of 1917, the Revenue Act of 1918, and the Revenue Act of 1921, as well as the Revenue Act of 1924. A corporation cannot distribute earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, exempt from tax, unless and until all earnings or profits accumulated since February 28, 1913, have been distributed. Whenever one corporation receives from another corporation distributions out of earnings or profits accumulated by such other corporation prior to March 1, 1913, or out of increase in value of its property accrued prior to March 1, 1913, and the "receiving" corporation, after having first distributed all of its earnings and profits accumulated since February 28, 1913, distributes to its stockholders the amount so received by it from such other corporation, the distribution by the "receiving" corporation to its stockholders is not a dividend within the meaning of the act and is exempt from tax.

In determining whether a dividend is out of earnings or profits accumulated since February 28, 1913, or prior to March 1, 1913, due consideration must be given to the facts, and mere bookkeeping entries increasing or decreasing surplus will not be conclusive.

A tax-free distribution made by a corporation out of earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, shall be applied against the basis of the stock for the purpose of determining gain or loss from its subsequent sale. The fact that such distribution is in excess of the cost or other basis (provided in articles 15911603) of the stock on which declared does not render it subject to tax. The provisions of this paragraph are also applicable to a distribution by a "receiving" corporation made under the conditions set forth in the first paragraph of this article, and to the distributees in determining gain or loss from the subsequent sale or other disposition of stock in the receiving corporation.

Example. A purchased certain shares of stock subsequent to February 28, 1913, for $10,000. He received in 1924 a distribution of $2,000 paid out of earnings and profits of the corporation accumulated prior to March 1, 1913. This distribution is not subject to tax, if the earnings and profits of the corporation accumulated after February 28, 1913, have

been distributed. If A subsequently sells the stock for $6,000, a deductible loss of $2,000 is sustained. If he sells the stock for $9,000, he realizes a taxable gain of $1,000.

ART. 1544. Distributions other than those out of earnings or profits. Any distribution (not in partial or complete liquidation) made by a corporation to its shareholders otherwise than out of (1) increase in value of property accrued prior to March 1, 1913, or (2) earnings or profits, shall be taxable to the recipient only if and to the extent that such distribution exceeds the basis of his stock, as provided in section 204. (See article 1591 et seq.) Any such distribution, however, shall be applied against and reduce the cost or other basis of the stock upon which declared, for the purpose of determining the gain or loss from the subsequent sale of the stock. The amount by which such distribution exceeds the basis of the stock constitutes taxable income.

Example. A purchased certain stock in 1915 for $10,000. (1) If he receives in 1924 a distribution thereon of $2,000 paid by the corporation otherwise than out of its earnings or profits or the increase in value of property accrued prior to March 1, 1913, this distribution does not constitute taxable income to A. If A subsequently sells the stock the difference between the amount realized therefor and $8,000 is taxable gain or deductible loss, as the case may be. (2) If, however, A receives a distribution of $12,000 in 1924 paid by the corporation otherwise than out of its earnings or profits or the increase in value of property accrued prior to March 1, 1913, A realizes taxable income to the extent of $2,000, which at his option may be taxed as a capital gain. (See article 1651.) ART. 1545. Distributions in liquidation.— Amounts distributed in complete liquidation of a corporation are to be treated as in full payment in exchange for the stock, and amounts distributed in partial liquidation are to be treated as in part or full payment in exchange for the stock so canceled or redeemed. The phrase "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. A complete cancellation or redemption. of a part of the corporate stock may be accomplished, for example, (1) by the complete retirement of all shares of a

particular preference or series, (2) by taking up all the old shares of a particular preference or series and issuing new shares to replace a portion thereof, or (3) by stamping on the old shares a notation of the reduction in their par value.

The gain or loss to a shareholder from a distribution in liquidation is to be determined as provided in article 1561, by comparing the amount of the distribution with the cost or other basis of the stock provided in section 204; but the gain or loss will be recognized only to the extent provided in articles 1571-1578. Any gain to the shareholder may, at his option, ⚫ be taxed as a capital net gain in the manner and subject to the conditions prescribed in section 208. In the case of amounts distributed in partial liquidation, other than a distribution in pursuance of a plan of reorganization as described in subdivision (g) of section 203, 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 section 201(b) for the purpose of determining the taxability of subsequent distributions by the corporation.

Examples. (1) A owns 10 shares of stock in M corporation for which he paid $1,250 in 1921. He receives in 1924 a dividend of $1,500 in complete liquidation. A is subject both to the normal tax and to the surtax upon his profit of $250, or at his option, in lieu of such taxes, to the tax upon capital net gain, as provided in section 208.

(2) A owns 10 shares of preferred stock and 10 shares of common stock in M corporation which he purchased in 1915 for $1,100 and $1,000 respectively. In 1924 M corporation has on hand $225,000 of capital, earnings and profits of $25,000 accumulated prior to March 1, 1913, and earnings and profits of $125,000 accumulated after February 28, 1913. If the preferred stock is retired at $125 per share, $125,000 being used by the corporation for this purpose, A will receive $1,250 in exchange for his 10 shares of preferred stock and is therefore subject to the normal tax and the surtax on $150, or at his option, in lieu of such taxes, to the tax upon capital net gain, as provided in section 208. If M corporation then distributes a cash dividend of $25,000 on the common stock, it would be subject to the surtax. If, without any further accumulation of earnings and profits, M corporation thereafter liquidates completely, A, who will receive $2,250 in exchange

for his 10 shares of common stock, will be subject to the normal tax and the surtax on $1,250, or at his option, in lieu of such taxes, to the tax upon capital net gain, as provided in section 208.

ART. 1546. Distributions from depletion or depreciation reserves. A reserve set up out of gross income by a corporation and maintained for the purpose of making good any loss of capital assets on account of depletion or depreciation is not a part of surplus out of which ordinary dividends may be paid. A distribution made from a depletion or a depreciation reserve based upon the cost of the property will not be considered. as having been paid out of earnings or profits, but the amount thereof shall be applied against and reduce the cost or other basis of the stock upon which declared for the purpose of determining the gain or loss from the subsequent sale of the stock. If such a distribution is in excess of the basis, the excess shall be taxed as a gain from the sale or other disposition of property. A distribution made from a depletion reserve based on the discovery value of a mine shall be similarly treated (by virtue of section 201 (d) of the Act), but a distribution from any other depletion reserve based upon discovery value, to the extent that such reserve represents the excess of the discovery value over cost or March 1, 1913, value is, when received by the shareholders, taxable as an ordinary dividend. (See also article 1544.) A distribution made from that portion of a depletion reserve based upon a valuation as of March 1, 1913, which is in excess of the depletion reserve based upon cost, will not be considered as having been paid out of earnings or profits, but the amount of the distribution shall be applied against and reduce the cost or other basis of the stock upon which declared for the purpose of determining the gain or loss from the subsequent sale of the stock. No distribution, however, can be made from such a reserve until all the earnings or profits of the corporation have first been distributed.

ART. 1547. Dividends paid in property.- Dividends paid in securities or other property (other than its own stock), in which the earnings of a corporation have been invested, are income to the recipients to the amount of the market value of such property when receivable by the shareholders, except as provided in article 1574 below. Where a corporation declares

a dividend payable in stock of another corporation, setting aside the stock to be so distributed and notifying the stockholders of its action, the income arising to the recipients of such stock is its market value at the time the dividend becomes payable. (See article 52.) Scrip dividends are subject to tax in the year in which the warrants are issued.

ART. 1548. Sale of stock received as dividend.-The issuance of its own stock by a corporation as a dividend to its shareholders does not constitute taxable income to such shareholders, but gain may be derived or loss sustained by the shareholders from the sale of such stock. The amount of taxable gain derived or deductible loss sustained from the sale of such stock, or from the sale of the stock with respect to which it is issued, shall be determined as provided in articles 1591 to 1599.

ART. 1549. Declaration and redemption of a stock dividend. If a corporation, either before or after the distribution of a stock dividend, 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 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.

LYNCH v. TURRISH

(Supreme Court of the United States, 1918. 247 U. S. 221, 38 Sup. Ct. 537, 62 L. ed. 1087, 3 Am. Fed. Tax R. 2986.)

Mr. Justice MCKENNA delivered the opinion of the Court. Suit to recover an income tax, paid under protest, assessed under the Act of October 3, 1913, c. 16, 38 Stat. 166.

The facts, as admitted by demurrer, are these: Respondent, Turrish, who was plaintiff in the trial court, made a return of his income for the calendar year 1914 which showed that he had no net income for that year; afterwards the Commissioner of Internal Revenue made a supplemental assessment showing that he had received a net income of $32,712.08, which, because of specific deductions and exemptions, resulted in no normal tax, but as the net income exceeded the sum of $20,000 the Commissioner assessed an additional or super tax