Harder v. Irwin

• Decision Date: 02 January 1923
• Citation: 285 F. 402
• Parties: HARDER v. IRWIN, Collector of Internal Revenue.
• Court: U.S. District Court — Northern District of New York

285 F. 402

HARDER v. IRWIN, Collector of Internal Revenue.

United States District Court, N.D. New York.

January 2, 1923

Gilbert & Gilbert, of New York City (A. S. Gilbert, of New York City of counsel), for plaintiff.

Hiram C. Todd, U.S. Atty., of New York City, and Earl H. Gallup Asst. U.S. Atty., of Albany, N.Y. (Carl A. Mapes, of Washington, D.C., Solicitor of Internal Revenue, and Chester A. Gwinn, of Washington, D.C., of counsel), for defendant.

COOPER District Judge.

This is an action brought by plaintiff to recover the sum of $29,958.88 income tax for the year 1917, which she alleges was illegally exacted from her by the defendant as internal revenue collector. The facts are substantially undisputed and are as follows:

In 1917, and for some years prior thereto, the High Rock Knitting Company (hereinafter referred to as the company or corporation) was a manufacturing concern having its principal office and place of business at Philmont, N.Y. The plaintiff was a stockholder, owning 1,200 shares of a total of 3,500 shares of common stock of the corporation, of the par value of $100 each. The principal source of plaintiff's income was from this stock. On December 12, 1917, the board of directors of said corporation adopted the following resolution:

'Motions were then passed to declare and pay on December 15th to common stockholders of record of that date, the following dividends: 20 per cent. from cash surplus accumulated during 1916; 60 per cent. from cash surplus accumulated during 1915; 120 per cent. from cash surplus accumulated prior to December 31, 1913.'

On December 20, 1917, the corporation, pursuant to said resolution, distributed in dividends the sum of $700,000, of which the plaintiff received $240,000, and in her income tax return for the year 1917 plaintiff reported the amount received by her from the High Rock Knitting Company, and allocated 20 per cent. thereof as taxable under the 1916 rates, 60 per cent. as taxable under the 1915 rates, and 120 per cent. thereof as nontaxable, because declared by the resolution as payable out of profits accrued before March 1, 1913. When the books for the year 1917 were audited by Price, Waterhouse & Co., some time after the close of the calendar year, it was shown that the profits of the company for the year 1917 were $424,958.53, after allowing $250,000 for corporate income tax for that year.

The Internal Revenue Department, on auditing plaintiff's return for the year 1917, made the claim that the first $400,000 of the $700,000 distributed by the company must be taken out of the earnings for the year 1917 and taxable to the stockholders at the rate in force for that year. The department therefore imposed an additional assessment on the plaintiff in the sum of $30,611.12, which she paid under protest. The plaintiff, upon a reaudit of her account, conceded that all of the 1916 surplus had to be exhausted before resorting to the accumulation prior to March 1, 1913, and so claimed only the sum of $29,958.88 as having been erroneously assessed.

The case turns upon the construction to be given section 31(b) of the Revenue Act of 1916, as amended by the Act of October 3, 1917 (40 Stat. 300 (Comp. St. Sec. 6336z)). The language of the section, so far as applicable to this case, is as follows:

'Any distribution made * * * in the year nineteen hundred and seventeen * * * 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.'

Two questions are presented: (1) Whether the word 'deemed,' in section 31(b) means a conclusive presumption, or merely a rebuttable presumption. (2) Assuming that the word 'deemed' is to be construed as an absolute requirement or conclusive presumption, must corporate profits earned in the year 1917 be included in the corporation's 'most recently accumulated undivided profits or surplus' within the meaning of section 31(b)?

To ascertain the intention of Congress, it is necessary to refer briefly to each Income Tax Act since the adoption of the Sixteenth Amendment, with reference to its application to the distribution of the earnings of corporations to the shareholders thereof. Acts relating to income tax were passed in 1913, 1916, and 1917. Under the income tax act of 1913, retroactive to March 1, 1913, dividends distributed during the taxable period of 1913 and the years of 1914 and 1915 were taxable to the recipients, under the 'surtax' provision, at the rates current during those years, whether the profits out of which such dividends were declared were accumulated before or after March 1, 1913. Lynch v. Hornby, 247 U.S. 339, 38 Sup.Ct. 543, 62 L.Ed. 1149; Southern Pacific v. Lowe, 247 U.S. 330, 38 Sup.Ct. 540, 62 L.Ed. 1142. The 1916 act, however, permitted the declaration of dividends tax free out of surplus created prior to March 1, 1913, even though profits earned subsequent to March 1, 1913, remained undistributed, leaving dividends declared from profits earned since March 1, 1913, taxable at the rate in existence at the time such dividends were received by the stockholders, as in the act of 1913.

Under the amendments of 1917, passed October 3, 1917, profits accumulated prior to March 1, 1913, might still be distributed tax free, 'after the distribution of earnings and profits accumulated since March 1, 1913, has been made,' and dividends paid from earnings accumulated since March 1, 1913, were made taxable at the rates in effect during the years when the profits out of which the dividends were made were accumulated, instead of at the rates of the year in which they were received, with a new provision added that any distribution made during the year 1917, or any subsequent year, 'shall be deemed to have been made from the most recently accumulated undivided profits or surplus.'

The act of October 3, 1917, was passed almost six months after the United States had entered the World War, and was entitled 'An act to provide revenue to defray war expenses and for other purposes. ' Taxes and surtaxes were increased generally by this statute, and it is evident that the object of the statute was to raise large revenues needed in emergency to successfully carry on the war.

The word 'deemed,' as used in the amendment of 1917, is a transitive verb, defined in Webster's New Unabridged Dictionary as:

'To sit in judgment over or upon; to judge; also to pronounce judgment upon; to decide; to regard.'

The word 'deemed' has been judicially defined. In Leonard v. Grant (C.C.) 5 Fed. 11, 16, it is stated that:

"Deemed' is the equivalent of 'considered' or 'adjudged,' and therefore whatever an act requires to be 'deemed' or 'taken' as true of any person or thing, must, in law, be considered as having been duly adjudged or established concerning such person or thing, and have force and effect accordingly.'

In U.S. v. Doherty (D.C.) 27 F. 730, 734, it was thus defined:

"Deem' means 'judge;' 'determine on consideration.' The primary meaning of the word is to form a judgment; to conclude on consideration. ' Words and Phrases, First Series, 'Deem.'

There are several other judicial expressions of the word 'deemed,' among them being in Walton v. Cavin, 16 Q.B. 48, 81, where it was stated that where a person was 'deemed' to be a soldier it must be understood to mean that he was thereafter to be taken in that capacity.

Also, in Cardinel v. Smith, 5 F. Cas. 45, 47, No. 2,395, the statute provided that dealers in canned goods under certain circumstances shall be deemed to be manufacturers and the court stated that they were to be held liable as manufacturers, notwithstanding that they were not such in fact. Other cases to the same effect are Lawrence & Co. v. Seyburn, 202 F. 913, 121 C.C.A. 271; Michel v. Nunn (C.C.) 101 F. 423, 424.

It is evident from the general scheme of the statute that it was the intention of Congress in the amendment of 1917 to require not only distribution of the earnings and profits accruing since March 1, 1913, which distribution is subject to tax, before there could be a tax free distribution of earnings and profits accruing prior to that date, but also a distribution of the most recent and most highly taxable profits or earnings before resort could be had to the earlier profits even though earned since March 1, 1913, and therefore also taxable, but at a less rate. Section 31 (b) of the 1917 amendment was enacted to express such purpose.

To permit the distributing corporation or the taxpayer to determine out of what profits the dividends are distributed is out of harmony with both the language of the section and the intent of the act. The same section further provides that:

'This subdivision shall not apply to any distribution made prior to August 6, 1917, out of earnings or profits accrued prior to March 1, 1913.'

If the provision of section 31 (b) merely created a rebuttable presumption, enabling the corporation to elect out of what years accumulated distributions are made, then there would have been no need for inserting the provision exempting distributions made before August 6, 1917, out of earnings or profits accrued prior to March 1, 1913.

The corporation may not, therefore, by its act declare that its distribution of dividends at any time after the act of October, 1917, is out of profits accumulated in earlier years, if there are profits of later years untouched. To do so is void because in conflict with the statute. The statute means that, regardless of the form of the declaration, it is...