The distributions in kind contemplated by article 1566 (before amendment) are not immediately taxable. However, 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.

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 of clear cases—one immediately 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 Received by Corporations

The 1918 law imposes no tax on dividends received by one corporation from another corporation (unless received from a foreign corporation not taxable in the United States upon its net income)." The dividends are to be included in gross income, but the full amount may be deducted in ascertaining net income.

It is now recognized that it is not equitable to impose tax on dividends received by a corporation, because the normal tax has already been paid on the earnings so distributed. Furthermore, when a corporation, which has received dividends,

in turn pays out its own net income in dividends, the recipients (if individuals) are subject to the surtax. Therefore, any income tax assessed against dividends received by corporations is double taxation. The 1913, 1916 and 1917 laws all imposed expressly or by implication full or partial income taxes upon dividends received by corporations, but the 1918 law granted full credit for dividends received in determining the taxes payable by the receiving corporation.*

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Dividends (received by corporations) which are not taxable.-Under the 1916, 1917 and 1918 laws, dividends payable out of surplus accrued prior to March 1, 1913, are not taxable. This provision applies to corporations as well as to individuals.18

Under the 1913 law, the Supreme Court has held that dividends received prior to December 31, 1915, are taxable even though paid out of surplus accrued prior to March 1, 1913," but in a recent case an exception was made to the rule. 45 The departure from the rule was justified by the court on the ground that the holding company was in actual possession and control of the funds represented by dividends prior to March 1, 1913, and that the declaration of the dividends after March 1, 1913, merely resulted in bookkeeping entries, there being no transfer of cash or property nor in fact any change in actual status. As stated by the court, "the payment was only constructive."

46

In a more recent case the Supreme Court again decided that a dividend paid out of surplus accrued prior to March I, 1913, was not taxable, on the ground "that the transaction should be regarded as bookkeeping rather than as dividends declared and paid in the ordinary course by a corporation."

"[Former Procedure] For regulations and procedure under former laws see Income Tax Procedure, 1919, pages 344-347. "Section 201 (a).

"Lynch v. Hornby, 247 U. S. 339 (June, 1918).

"Southern Pacific Company v. Lowe, 247 U. S. 330 (June, 1918). Gulf Oil Corporation v. Lewellyn, 248 U. S. 71 (December 9, 1918).

INCOME FROM STOCK DIVIDENDS

It was generally believed that during the year 1919 the Supreme Court of the United States would finally settle the much discussed problem of stock dividends. In the case of Towne v. Eisner,' decided under the 1913 law, the Supreme Court held that stock dividends were not taxable.

DECISION. The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones. pened is that the plaintiff's old certificates effect and have diminished in value to the the new.

3

. . . . What has hap

....

have been split up in extent of the value of

In the case of Macomber v. Eisner 2 a United States district court held that stock dividends declared under the 1916 law were not taxable. The case was appealed to the Supreme Court and was argued in April, 1919. No decision has been rendered at the time this is written. In May, 1919, the Supreme Court announced that it would hear a reargument. The case was reargued in November, 1919, and it was hoped that a decision would be announced before the end of the calendar year 1919.

It is fruitless to discuss the probable decision of the court. If it decides that stock dividends are not taxable, no return need be made of dividends received during 1919, and refunds may be obtained of all taxes paid on account of stock dividends reported during 1916, 1917 and 1918. If the court decides that stock dividends are taxable, no change will be made in the procedure of the Treasury because it has refused to abide

'245 U. S. 418 (January 7, 1918).

'Decided January 23, 1919. 'December 27, 1919.

by the decision of the district court and has imposed the tax on all stock dividends received since January 1, 1916.

Under the 1918 law, stock dividends, when declared between January I and November 1, 1918, and paid prior to March 27, 1919, (thirty days after the passage of the 1918 law), are taxable at the rates prescribed for the prior periods when the earnings were accumulated (but the 1918 earnings up to the date the stock dividend was paid must first have been distributed).

Stock dividends declared on or after November 2, 1918, and paid on or before December 31, 1919, are taxable at the 1918 rates which are the same as in 1919.

Stock dividends received during the period March 1, 1913, to December 31, 1915, are not taxable at all.

Stock dividends received during the years 1916 and 1917, until decided otherwise by the Supreme Court, are taxable the same as cash dividends.

The foregoing statements are discussed hereinafter.

LAW. Section 201. (a) That the term "dividend" when used in this title. . . . means (1) any distribution made by a corporation, . . . . to its shareholders . . . . in stock of the corporation, out of its earnings or profits accumulated since February 28, 1913, . . . .

(c) A dividend paid in stock of the corporation shall be considered income to the amount of the earnings or profits distributed. . . .

(d) If any stock dividend (1) is received by a taxpayer between January I and November 1, 1918, both dates inclusive, or (2) is during such period bona fide authorized or declared, and entered on the books of the corporation, and is received by a taxpayer after November 1, 1918, and before the expiration of thirty days after passage of this Act, then such dividend shall, in the manner provided in section 206, be taxed to the recipient at the rates prescribed by law for the years in which the corporation accumulated the earnings or profits from which such dividend was paid, but the dividend shall be deemed to have been paid from the most recently accumulated earnings or profits.

Should a stock dividend be taxed?-For many years the treatment of stock dividends as a taxable item has puzzled

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the courts and tax administrators. The author fully discussed the entire subject in Income Tax Procedure, 1918. Since that time the decisions in the Towne and Macomber cases have been rendered. The illuminating opinion written by Mr. Justice Holmes in the Towne case is reproduced in full on page 492 hereof. The author does not believe that the present attitude of Congress (as indicated by the 1918 law) or of the Treasury, in regard to stock dividends paid since January 1, 1916, conforms to the Towne decision. There is some change in the wording of the 1913 and 1916 laws but in neither does it affect the fundamental question. As has been well

The real distinction to be kept continually in mind in threading one's way through the mazes of the income tax is between the actual receipt of income on the one hand and the unrealized appreciation of capital on the other. A cash dividend is an example of the former; a stock dividend is an example of the latter. In the cash dividend, as in the "other stock" [securities of another corporation], the gain is realized and separated; in the stock dividend, as in the addition to surplus, the gain is unrealized and unseparated. The first is income; the second is capital. A cash dividend is income; a stock dividend is not income."

REGULATIONS. A dividend paid in stock of the corporation is income to the amount of the earnings or profits distributed, as shown by the transfer of surplus to capital account on the books of the corporation, usually equal to the par value of the stock distributed. But stock distributions made out of surplus other than earnings or profits accumulated since February 28, 1913, when there are no such earnings or profits, are not dividends within the meaning

[Former Procedure] The provision relating to dividends in the 1913 law did not mention stock dividends. T. D. 2090 (December, 1914) held that stock dividends were taxable. T. D. 2163 (February, 1915) held that stock dividends were not taxable. T. D. 2274 (December, 1915) held that stock dividends were taxable. The 1916 law [section 2 (a)] provided that dividends were taxable "whether in cash or in stock of the corporation . . .. which stock dividend shall be considered income to the amount of its cash value." For discussion of "cash value" see Income Tax Procedure, 1918, pages 204-211.

The 1917 law changed the words "cash value" to "to the amount of the earnings or profits so distributed." The term "to the amount of the earnings or profits so distributed" is defined in T. D. 2734 (June 17, 1918) as follows: "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."

"Are Stock Dividends Income?" Edwin R. A. Seligman, American Economic Review, September, 1919, page 536.