Towne v. Eisner

CourtUnited States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
Citation242 F. 702
PartiesTOWNE v. EISNER, Internal Revenue Collector.
Decision Date15 June 1917

Louis H. Porter, of New York City, for plaintiff.

H Snowden Marshall, U.S. Atty., of New York City (Ben A Matthews, Asst. U.S. atty., of New York City, of counsel) for defendant.

Archibald R. Watson, Paul D. Cravath, George Welwood Murray, and Charles E. Hughes, all of New York City, amici curiae.

AUGUSTUS N. HAND, District Judge.

This is an action to recover income taxes paid upon stock dividends under protest. The directors and stockholders of the Yale &amp Towne Manufacturing Company, having a surplus, all of which was earned prior to January 1 1913, voted on December 17, 1913, to transfer $1,500,000 thereof to its capital account and to apply the same to the payment of an issue of 15,000 shares of new stock, of the par value of $100 a share, and to distribute this stock pro rata among stockholders of record on December 26, 1913. The actual distribution was made January 2, 1914. The effect of this resolution was to increase the capital stock from $3,000,000 to $4,500,000, par. The resolution under which the stock dividend was declared also provided for scrip redeemable at par for fractional shares. The plaintiff was a holder of 8,349 shares of stock of the company, and upon distribution of the stock dividend received 4174 1/2 more. A tax of $20,208.94 was assessed upon his stock dividend, which he paid under protest, and now sues to recover.

The act of October 3, 1913, provides (section B):

' * * * The net income of a taxable person shall include gains, profits, and income derived from * * * interest, rent, dividends, securities, or the transaction of any lawful business carried on for gain or profit, or gains or profits and income derived from any source whatever.'

The ruling of the Treasury Department (Decision 2274, issued December 22, 1915) provides:

'Stock dividends paid from the net earnings or the established surplus or undivided profits of corporations * * * are held to be the equivalent of cash and to constitute taxable income under the same conditions as cash dividends.'

Gains and profits from business can only be taxed under the present Income Tax Act by virtue of ownership of the property from which they are derived. They are not, like excise taxes, based upon the earnings of a business, corporate or otherwise. They are direct taxes, under the decision of the Supreme Court in Pollock v. Farmers' Loan & Trust Co., 158 U.S. 601, 15 Sup.Ct. 912, 39 L.Ed. 1108, and would have to be apportioned, but for the recent enactment of the Sixteenth Amendment to the Constitution. This amendment provides that:

'The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.'

Now, it is manifest that the stock dividend in question cannot be reached by the Income Tax Act, and could not, even though Congress expressly declared it to be taxable as income, unless it is in fact income. It is likewise true that the word must be presumed to have been used in the constitutional amendment and in the act in the sense in which the Supreme Court had theretofore defined it, if a judicial definition had been clearly given. Kepner v. United States, 195 U.S.at page 124, 24 Sup.Ct. 797, 49 L.Ed. 114, 1 Ann.Cas. 655; Latimer v. United States, 223 U.S.at page 504, 32 Sup.Ct. 242, 56 L.Ed. 526; United States v. Baruch, 223 U.S. 191, 32 Sup.Ct. 306, 56 L.Ed. 399.

I cannot, however, accede to the contention of the plaintiff that stock dividends had received such a clear definition in the case of Gibbons v. Mahon, 136 U.S. 549, 10 Sup.Ct. 1057, 34 L.Ed. 525. That, like most, if not all, of the cases where the question has arisen, involved the consideration whether stock dividends are principal or income in a litigation between a life tenant and remainderman. The stock dividend was there principally based upon a surplus earned prior to the creation of the trust which received it, and the question involved was not whether or not the dividend was income, but whether it belonged to life tenant or remainderman. The Massachusetts courts, with a numerically small following, have adopted the English rule, and held all stock dividends to belong to the corpus of the trust fund, as between life tenant and remainderman, while New York, New Jersey, New Hampshire, Pennsylvania, Maryland, Wisconsin, and other states of the Union have adopted rules of apportionment. In the Matter of Osborne, 209 N.Y. 450, 103 N.E. 723, 823, 50 L.R.A. (N.S.) 510, Ann. Cas. 1915A, 298, the New York Court of Appeals held that extraordinary dividends, representing accumulated profits, whether distributable in cash or in the form of stock, are to be apportioned between the corpus of the trust and the income, in the proportion in which the surplus thus distributed has been earned before or after the creation of the trust fund.

These varying rules laid down for the guidance of trustees have been to a considerable extent rules of convenient administration. The English and Massachusetts law, which the Supreme Court adopted in Gibbons v. Mahon, supra, has the advantage of avoiding the difficulty and expense of investigating the facts upon which any apportionment must be based.

After the decision of Lowry v. Farmers' Loan & Trust Co., 172 N.Y. 137, 64 N.E. 796, it was thought by many New York trustees that extraordinary dividends, whether of cash or stock, if derived from an accumulation of corporate profits and thus appearing in the corporate resolutions, were distributable to the life tenant, irrespective of when they were earned. New York trustees began to rely upon this decision as laying down a definite, even if a rather unjust, rule, when a series of cases of which the Matter of Osborne, supra, was the culmination, practically, though not in terms, overruled Lowry v. Farmers' Loan & Trust Co., and established the method of apportionment I have mentioned.

The cases relating to distribution of extraordinary dividends by trustees are particularly designed to keep the corpus intact under all circumstances, and to furnish trustees with definite rules of conduct. A court may well hold that extraordinary dividends are always capital, because it thinks that so much trouble and expense is avoided that this consideration outweighs occasional injustice to the life tenant. The Supreme Court laid stress upon this consideration in Gibbons v. Mahon, supra, and Mr. Justice Gray remarked that the method of apportionment could not, ' * * * without producing great embarrassment and inconvenience, be left open to be tried and determined by the courts * * * and by a distinct and separate investigation * * * of the affairs and accounts of the corporation.'

I confess that, if strict justice between life tenant and remainderman is to be attained, I can imagine no other method than that of apportionment possible. The criterion adopted in these cases between life tenant and remainderman does not necessarily depend on whether the extraordinary dividend is in general income or not, but upon the person to whom it should belong in view of the date of the creation of the trust. For this reason I cannot regard the decision in Gibbons v. Mahon as determining the present issues, or the language of the court there as being at most anything more than a dictum in respect to the matters here involved.

I can give little weight to the argument that the issue of the stock dividend did not affect the market value of the plaintiff's aggregate holdings, and that the distribution of 50 per cent. more stock to the stockholders lessened the market price of their original stock 33 1/3 per cent. This would be true in case of any cash dividend, extraordinary, or even ordinary. The cash distributed, plus the market value of the stock after the dividend was paid, would ordinarily be equivalent in value to the stock before the dividend. But the objection seems...

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