Douglas v. Edwards

• Decision Date: 07 April 1924
• Docket Number: 95.
• Parties: DOUGLAS et al. v. EDWARDS, Collector of Internal Revenue.
• Court: U.S. Court of Appeals — Second Circuit

298 F. 229

DOUGLAS et al. v. EDWARDS, Collector of Internal Revenue.

No. 95.

United States Court of Appeals, Second Circuit.

April 7, 1924

[Copyrighted Material Omitted]

Writ of error to a judgment of the District Court for the Southern District of New York, entered on a directed verdict in favor of defendant, dismissing the complaint, and awarding costs against plaintiffs to defendant. The facts having been stipulated, only questions of law were in controversy, and each side, therefore, moved for the direction of a verdict with the result supra.

The action was brought to recover $173,579.72, additional income tax for 1917, paid under protest by plaintiffs to defendant collector. A claim for refund was duly made and denied. The additional tax was levied on two socalled depletion distributions made in September and December, 1917, by Phelps Dodge Corporation, a mining company, and received in his lifetime by James Douglas, a stockholder. It is contended by plaintiffs that these dividends were not income, and therefore not taxable, or, if income and taxable, then not at the 1917 rate, while defendant insists that the dividends were taxable as income and at the 1917 rate.

Phelps Dodge & Co., Inc., was organized under the laws of New York on December 14, 1908, with an authorized capital stock of $50,000,000, divided into 500,000 shares, of the par value of $100 each. $45,000,000 par value was issued for $90,000,000 of assets, of which $66,000,000 represented copper and coal mines and $24,000,000 other assets. The corporation thus had a capital stock of $45,000,000 and a paid-in surplus of $45,000,000. These assets were held by various subsidiary companies, but the history and relation of these companies need not be recited, as the parties agree that these antecedent details do not affect the controversy. By March 1, 1913, the assets of the corporation had increased in value to $153,275,606.69, of which $132,285,000 represented the value of its mines, and the balance represented the plant investments and other current assets.

On March 1, 1913, Douglas held 41,025 shares of the capital stock of Phelps, Dodge & Co., Inc. On July 2, 1913, he purchased 25 additional shares of such stock. He held this stock until April 1, 1917, when in the reorganization infra he exchanged his 41,050 shares in Phelps, Dodge & Co., Inc., for 41,050 shares in Phelps Dodge Corporation, which shares he held continuously until his death on June 25, 1918. On April 1, 1917, the business was reorganized in a manner not material to the issues here involved and Phelps Dodge Corporation (hereinafter called Phelps Co.) became the name of the reorganized company and became the parent company. For brevity and convenience, Phelps Co. will be understood to refer to the present and previous corporations.

From 1913 to 1917, inclusive, the mines owned by Phelps Co. were operated and the product sold, and in each year a certain amount was deducted from gross income and credited on the books of the company to a depletion reserve account, to make good the wastage caused by the operation of the mines. In 1918, Phelps Co. filed its income and excess profits tax returns for the year 1917. On December 1, 1919, the Commissioner of Internal Revenue made a provisional valuation for depletion and other purposes of the various mining properties owned as of March 1, 1913. It was held that Phelps Co. had an outstanding capital stock of $45,000,000, a paid-in surplus of $45,000,000, and the 'total value fixed by the bureau as of March 1, 1913,' of all the company's mines was $132,285,000.

Upon the basis of the foregoing valuation, the income and excess profits tax returns of Phelps Co. for the years 1917 and 1918 were audited and closed by the Commissioner of Internal Revenue and the tax paid. These taxes of the corporation were adjusted to make them correspond with the revised depletion figures. Phelps Co. had set up on its books a depletion reserve from 1913 to 1917, inclusive, which for these years aggregated 14,416,783.88. This depletion reserve was revised by the Commissioner of Internal Revenue, and increased for this period to $25,837,427.91. The summary memorandum of the changes in financial conditions of Phelps Co. from 1912 to 1917 is noted in the table following for convenient reference:

Plaintiff's Exhibit D. Phelps Dodge Corporation. Memorandum re Changes in Financial Condition--1912-1917. 1912 1913 1914 1915 1916 1917 Total Income, before deducting depletion ........................... 11,120,368.73 8,216,266.66 10,501,310.77 23,675,783.01 22,456,906.32 75,970,635.49 Depletions, at Treasury Department's rates ................... 4,747,251.87 4,572,808.56 4,877,786.88 5,925,161.34 5,714,419.26 25,837,427.91 -------------- -------------- -------------- -------------- -------------- ------------- Profits ................................ 6,373,116.86 3,634,458.10 5,623,523.89 17,750,621.67 16,742,487.06 50,133,207.58 -------------- -------------- -------------- -------------- -------------- ------------- Dividends paid from earned surplus ....................... 7,425,000.00 6,300,000.00 9,000,000.00 14,625,000.00 10,800,000.00 48,150,000.00 Distributions of proceeds of depletion .................................. ...... ...... ...... ...... 3,600,000.00 3,600,000.00 -------------- -------------- -------------- -------------- -------------- ------------- Total Distributions to stockholders ...................... 7,425,000.00 6,300,000.00 9,000,000.00 14,625,000.00 14,400,000.00 51,750,000.00 -------------- -------------- -------------- -------------- -------------- ------------- Capital expenditures: Mines ................................... 678,421.98 183,796.91 488,141.54 1,508,138.54 3,796,653.03 6,287,558.18 Plants ................................ 1,088,392.37 1,435,008.46 1,668,945.69 1,508,655.32 1,414,682.28 7,115,684.12 Investments ............................. 136,386.38 390,213.44 4,393.00 249,101.17 585,267.02 77,945.79 -------------- -------------- -------------- -------------- -------------- ------------- Total capital expenditures ......................... 1,903,200.73 1,860,998.11 2,152,694.23 2,767,692.69 5,796,602.33 13,481,188.09 -------------- -------------- -------------- -------------- -------------- ------------- Balance sheets, 31st December: Mines .............. $132,285,000.00 128,216,170.11 123,459,564.64 119,069,919.30 114,652,896.50 112,735,130.27 Plants ................ 5,281,367.23 5,911,154.45 8,253,318.46 9,440,549.51 10,445,211.45 11,484,535.18 Investments ........... 3,151,535.24 3,287,921.62 2,897,708.18 2,893,315.18 2,644,214.01 3,129,481.03 Current assets derived from depletion .................. ...... 4,068,829.89 8,825,435.36 13,265,080.70 17,632,103.50 15,949,869.73 Current assets--other ....... 12,557,704.22 10,739,647.48 6,131,155.01 1,521,840.85 3,931,901.75 8,359,798.06 --------------- -------------- -------------- -------------- -------------- -------------- Total assets ...... $153,275,606.69 152,223,723.55 149,567,181.65 146,190,705.54 149,316,327.21 151,658,814.27 --------------- -------------- -------------- -------------- -------------- -------------- Capital stock ..... $ 45,000,000.00 45,000,000.00 45,000,000.00 45,000,000.00 45,000,000.00 45,000,000.00 Surplus--prior to 1913 ............... 108,275,606.69 107,223,723.55 104,567,181.65 101,190,705.54 101,190,705.54 97,590,705.54 --since 1913 ....................... ...... ...... ...... ...... 3,125,621.67 9,068,108.73 --------------- -------------- -------------- -------------- -------------- -------------- Total capital ....... $153,275,606.69 152,223,723.55 149,567,181.65 146,190,705.54 149,316,327.21 151,658,814.27 --------------- -------------- -------------- -------------- -------------- -------------- 'That this company distribute among its stockholders, from said depletion account, $3 a share, to be paid on September 28, 1917, to stockholders of record on September 24, 1917, the total amount so paid to be deducted from said depletion account.'

In December, 1917, a similar resolution was passed, this time, however, distributing $5.00 per share to the stockholders. The total distribution of these so-called depletion dividends aggregated $3,600,000, and the amounts received by Douglas were, respectively, $123,150 and $205,250, or a total of $328,400. The return of Phelps Co. for the year 1917 was audited on or about March 2, 1920, and the 1917 income and excess profit taxes of Phelps Co. were finally determined on or about that date.

'Sec. 31 (a). That the term 'dividends' as used in this title shall be held to mean any distribution made or ordered to be made by a corporation, * * * out of its earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its shareholders, whether in cash or in stock of the corporation, * * * which stock dividend shall be considered income, to the amount of the earnings or profits so distributed.

'Sec 31 (b). Any distribution made to the shareholders or members of a corporation, * * * in the year nineteen hundred and seventeen, or subsequent tax years, shall be deemed to have been made from the most recently accumulated undivided profits or surplus, and shall constitute a part of the annual income of the distributee for the year in which received, and shall be taxed to the distributee at the rates prescribed by law for the years in which such profits or surplus were accumulated by the corporation, * * * but nothing herein shall be construed as taxing any earnings or profits accrued prior to March first, nineteen hundred and thirteen, but such earnings or profits may be distributed in stock dividends or otherwise, exempt from the tax, after the distribution of earnings and profits...