ROYALTIES FROM PATENTS AND COPYRIGHTS. Royalties on patents are income.45 Taxpayers receiving royalties from patents, copyrights, or other similar forms of property, may deduct from each payment a proportionate part of the cost thereof as representing a return of capital. This is more fully discussed in a subsequent chapter.46

ore lands and they contained substantially the following provisions: (1) that the owners leased to the lessees exclusively all the lands described for the purpose of exploring for, mining, and removing the ore which might be found therein for the period of fifty years; (2) the lessees were given the exclusive right to occupy and control the leased premises and to erect all necessary buildings, etc., thereon, (3) right was reserved to the lessors to enter for the purpose of ascertaining the amount of ore mined and removed and of making observations, etc.; (4) the lessees agreed to pay in most cases a certain price per ton for all ore mined and removed; (5) the lessees agreed to mine and ship a specified quantity of ore each year in default of which they agreed to pay the lessors for a minimum amount; (6) the lessees agreed to pay taxes and to keep the property free from encumbrances; (7) the lessors reserved the right to terminate the lease upon default of the lessees; (8) the lessees had the right to terminate the leases upon sixty days notice. The Supreme Court held that moneys received under these leases did not represent, in whole or in part, conversion of the investment of the lessors from ore into money, but on the contrary they represented the rents and profits of the land, to be accounted for as income by the recipient lessors. In the Biwabik Case the leases involved contained substantially similar provisions and the lands leased contained deposits of iron ore. The Court expressly stated in this case that its findings in the Sargent Case left "little room to suppose that this Court made its decision concerning the rights of the lessor influenced by the fact that the land itself was the chief thing, and the ownership of it after the exhaustion of the minerals one of the controlling reasons in reaching the conclusion announced in that case." The Court repeated its decision in the Sargent Case that the lessee was in no legal sense the purchaser of ore in place. Owing to the migratory, fugitive, and volatile character of oil and gas the rights and ownership therein are to be determined according to special rules and not according to the rules which prevail in the case of ore, coal and other solid minerals. (Ohio Oil Co. v. Indiana, 177 U. S. 190; Brown v. Spilman, 155 U. S. 665.) It may be that royalties upon oil and gas leases are for this reason distinguishable from royalties upon solid mineral leases, but the point has never been expressly determined with reference to the income tax.

45 Reg. 45, Art. 48.

46 See Chapter 26.

CHAPTER 19

INCOME FROM DIVIDENDS

The law expressly states that the gross income of a taxpayer shall include gains, profits and income derived from dividends.1

Definitions. The term "dividend," as used in the Revenue Act of 1918 (with one exception where it is used in connection with dividends paid by insurance companies on policy and annuity contracts) is defined therein to mean (1) any distribution made by a corporation, other than a personal service corporation, to its shareholders or members, whether in cash or in other property or in stock of the corporation, out of its earnings or profits accumulated since February 28, 1913, or (2) any such distribution made by a personal-service corporation out of its earnings or profits accumulated since February 28, 1913, and prior to January 1, 1918.2 Amounts distributed in the liquidation of a corporation are expressly required to be treated as payments in exchange for stock or shares, and any gain or profits realized thereby will be taxed to the distributee as other gains or profits. It is to be noted that under this definition any distribution in the ordinary course of business, though extraordinary in amount, and other than a distribution in liquidation which is made by a corporation of earnings or profits accumulated since February 28, 1913, is a dividend; it need not necessarily be called a dividend. On the other hand, if the distribution is not out of earnings or

1 Revenue Act of 1918, §§ 213 (a) and 234 (a) 10. The Revenue Act of 1916 provided that subject only to such exemptions and deductions as were thereinafter allowed, the net income of a taxpayer should include gains, profits and income derived from dividends (Revenue Act of 1916, § 2 (a)).

2 Revenue Act of 1918, § 201 (a); Reg. 45, Arts. 1541 and 1543. It will be noted that the new definition, aside from its provision for personal service corporation distributions, omits the words, "or ordered to be made;"' substitutes the word "accumulated" for "accrued;" and also expressly includes distributions made "in other property." See Revenue Act of 1916, § 31 (a), Reg. 33 Rev., Art. 106.

3 Revenue Act of 1918, § 201 (c). Reg. 45, Art. 1548.

profits accumulated since February 28, 1913 (and prior to January 1, 1918, in the case of personal service corporations), it does not become a dividend within the meaning of the law by reason of the fact that it is called a dividend by the corporation making the distribution.$

DIVIDENDS ON LIFE INSURANCE POLICIES. It is a custom of insurance companies to return each year a portion of the premium paid by the insured. The amount so returned is usually designated as a "dividend" and is either received in cash by the insured or applied by him to the reduction of the next annual premium. The law expressly provides that amounts received as a feturn of premiums paid by the taxpayer is not income.5 Where, however, dividends are received on a paid-up policy their amount should be considered the same as dividends from corporations, unless, of course, the dividend was not paid by the insurance company out of earnings or profits accumulated since the incidence of the tax.

DIVIDENDS FROM ASSOCIATIONS. Since associations, joint-stock companies and insurance companies (whether incorporated or not) are treated as corporations and limited partnerships may be so treated, the net earnings of such organizations when distributed should be considered dividends. Thus, under the 1916 Law and former laws private banks, which had the form of corporate organization, were required to make returns as corporations, and the owners of the bank were authorized to treat as dividends the earnings which they received therefrom. The recipient of profits of associations or limited partnerships should, therefore, ascertain whether the association or partnership is paying the tax as a corporation and in such event should treat any part of the net profits of the association received by him as dividends.

DIVIDENDS FROM COOPERATIVE ASSOCIATIONS. Dividends paid by cooperative associations, acting as sales agents for farmers or others, in the nature of a periodical refund or rebate to members or prospective members or patrons generally, are wholly dif

4 Reg. 45, Art. 1541.

5 Revenue Act of 1918, § 213 (b) 2.

6 T. D. 2137.

7 See the discussion of limited partnerships in Chapter 8.

8 T. D. 2152.

9 T. D. 2137.

ferent from ordinary distributions based upon stockholdings and may be excluded from gross income by their recipients. Any profits of such associations made from non-members and distributed to members in the guise of rebates are, of course, subject to tax.10

DIVIDENDS FROM FEDERAL RESERVE BANK. Section 7 of the Federal Reserve Act of December 23, 1913, provides that federal reserve banks, including the capital stock and surplus therein and the income derived therefrom, shall be exempt from taxation, except taxes upon real estate. Such exemption attaches to and follows the income derived from dividends on stock of federal reserve banks in the hands of the stockholders, so that the dividends received on the stock of federal reserve banks are not subject to the income tax. Dividends paid by member banks, however, are treated like dividends of ordinary corporations.11

DIVIDENDS AND INTEREST FROM FEDERAL LAND BANK AND NATIONAL FARM LOAN ASSOCIATION. As section 26 of the Federal Farm Loan Act of July 17, 1916, provides that every federal land bank and every national farm loan association, including the capital and reserve or surplus therein and the income derived therefrom, shall be exempt from taxation, except taxes upon real estate, and that farm loan bonds, with the income therefrom, shall be exempt from taxation, the income derived from dividends on stock of federal land banks and national farm loan associations and from interest on such farm loan bonds is not subject to the income tax.1 12

DISTRIBUTION IN LIQUIDATION. So-called liquidation or dissolution dividends are not dividends within the meaning of the statute, and amounts so distributed, whether or not including any surplus earned since February 28, 1913, are to be regarded as payments for the stock of the dissolved corporation. Any excess so received over the cost of his stock to the stockholder, or over its fair market value as of March 1, 1913, if acquired prior thereto, is a taxable profit. A distribution in liquidation of the assets and business of a corporation, which is a return to the stockholder of the value of his stock upon a surrender of his interest in the cor

10 Reg. 45, Art. 522; T. D. 2737. See Chapter 13.

11 Reg. 45, Art. 76; Federal Reserve Bulletin, April 1, 1916.

12 Reg. 45, Art. 75; Reg. 33 Rev., Art. 86. Revenue Act of 1918, § 231 (13.)

poration, is distinguishable from a dividend paid by a going corporation out of current earnings or accumulated surplus when declared by the directors in their discretion, which is in the nature of a recurrent return upon the stock.13

13 Reg. 45, Art. 1548. See also Reg. 45, Arts. 1541 and 1543. This ruling is founded largely upon the distinction drawn by the United States Supreme Court in the cases of Lynch v. Turrish, 247 U. S. 221, and Lynch v. Hornby, 247 U. S. 339. It is to be noted that the question in both these cases was whether earnings or profits accumulated prior to March 1, 1913, should be considered as dividends. The question was not: Shall earnings or profits accumulated subsequent to March 1, 1913, be considered as dividends? In determining the former question the Supreme Court drew a distinction according to whether or not the distribution was a dividend in ordinary course or a final dividend in liquidation. This distinction does not affect the answer to the second question. The issue in the Turrish and Hornby cases was whether certain earnings or profits were essentially capital or income for tax purposes, whether they were taxable as income or exempt as capital. On the other hand, the question arising in the interpretation of § 201 of the Revenue Act of 1918 pertains to the character of the taxability of certain earnings and profits. The Supreme Court did not hold in the Turrish case that corporate gains and profits accumulated prior to March 1, 1913, are not "dividends" if paid to a stockholder upon a winding up of the affairs of a corporation; it declared that 1 such earnings or profits had become capital and were exempt therefore from tax when distributed. It did not hold in the Hornby case that corporate gains and profits accumulated prior to March 1, 1913, are dividends because they were paid to a stockholder by a corporation continuing in business or a going concern; it declared that such earnings or profits did not come into fruition as income to the stockholder until by virtue of an exercise of affirmative discretion on the part of the directors they were declared, that is, until they were separated from the corporation's general assets and the stockholder's interest was transformed from an inchoate and contingent interest in them to a definite and fixed share. It will be argued that a distribution which would have been a "dividend" under the Hornby case was held not to be a "dividend" in the Turrish case, solely because it was made upon the liquida-tion of the paying corporation and that therefore the essence of what would ordinarily be a "dividend" under the present law is changed by the same token. This argument is based upon the fallacy that the taxability of earnings or profits accumulated since the incidence of the tax is to be determined according to the same differentiation applying in the case of earnings or profits accumulated prior thereto. But, as stated above, the Turrish and Hornby cases divided on the question when, with reference to the incidence of the tax, a distribution became income. They did not settle the question: What kind of income are certain concededly taxable earnings or profits? The Court was not attempting in the Turrish and Hornby cases to distinguish between "dividends' and other distributions. It was drawing a line between capital and income, income received prior to March 1, 1913, having the status of capital.

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