Southern Pac Co v. Lowe

• Decision Date: 03 June 1918
• Docket Number: No. 452,452
• Citation: 62 L.Ed. 1142,247 U.S. 330,38 S.Ct. 540
• Parties: SOUTHERN PAC. CO. v. LOWE, Collector of Internal Revenue
• Court: U.S. Supreme Court

247 U.S. 330

38 S.Ct. 540

62 L.Ed. 1142

SOUTHERN PAC. CO.

v LOWE, Collector of Internal Revenue.

No. 452.

Argued March 4, 5, and 6, 1918.

Decided June 3, 1918.

Mr. Gordon M. Buck, of New York City, for plaintiff in error.

Mr. Solicitor General Davis, for defendant in error.

Mr. Justice PITNEY delivered the opinion of the Court.

This case presents a question arising under the Federal ncome Tax Act of October 3, 1913 (chapter 16, 38 Stat. 114, 166). Suit was brought by plaintiff in error against the collector to recover taxes assessed against it and paid under protest. There ware two causes of action, of which only the second went to trial, it having been stipulated that the trial of the other might be postponed until the final determination of this one. So far as it is presented to us, the suit is an effort to recover a tax imposed upon certain dividends upon stock, in form received by the plaintiff from another corporation in the early part of the year 1914, and alleged by the plaintiff to have been paid out of a surplus accumulated not only prior to the effective date of the act but prior to the adoption of the Sixteenth Amendment to the Constitution of the United States. The district court directed a verdict and judgment in favor of the collector (238 Fed. 847), and the case comes here by direct writ of error under section 238, Judicial Code (Act March 3, 1911, c. 231, 36 Stat. 1157 [Comp. St. 1916, § 1215]), because of the constitutional question. That our jurisdiction was properly invoked is settled by Towne v. Eisner, 245 U. S. 418, 425, 38 Sup. Ct. 158, 62 L. Ed. ——.

The case was submitted at the same time with several other cases arising under the same act and decided this day, viz., Lynch, Collector, v. Turrish, 247 U. S. 221, 38 Sup. Ct. 537, 62 L. Ed. ——, Lynch, Collector, v. Hornby, by, 247 U. S. 339, 38 Sup. Ct. 543, 62 L. Ed. ——, and Peabody v. Eisner, Collector, 247 U. S. 347, 38 Sup. Ct. 546, 62 L. Ed. ——.

The material facts are as follows: Prior to January 1, 1913, and at all times material to the case, plaintiff, a corporation organized under the laws of the state of Kentucky owned all the capital stock of the Central Pacific Railway Company, a corporation of the state of Utah, including the stock registered in the names of the directors.¹ This situation existed continuously from the incorporation of the Railway Company in the year 1899. That company is the successor of the Central Pacific Railroad Company and acquired all of its properties, which constitute a part of a large system of railways owned or controlled by the Southern Pacific Company. The latter company, besides being sole stockholder, was in the actual physical possession of the railroads and all other assets of the Railway Company, and in charge of it operations, which were conducted in accordance with the terms of a lease made by the predecessor company to the Southern Pacific and assumed by the Railway Company, the effect of which was that the Southern Pacific should pay to the lessor company $10,000 per annum for organization expenses, should operate the railroads, branches, and leased lines belonging to the lessor, and account annually for the net earnings, and if these exceeded 6 per cent. on the existing capital stock of the lessor the lessee should retain to itself one-half of the excess; advances by the lessee for account of the lessor were to bear lawful interest, and the lessee was to be entitled at any time and from time to time to refund to itself its advances and interest out of any net earnings which might be in its hands. The provisions of the lease were observed by both corporations for bookkeeping purposes. The Southern Pacific acted as cashier and banker for the entire system; the Central Pacific kept no bank account, its earnings being deposited with the bank account of the Southern Pacific; and if the Central Pacific needed money for additions and betterments or for making up a deficit of current earnings, the necessary funds were advanced by the Southern Pacific. As a result of these operations and of the conversion of certain capital assets of the Central Pacific Company, that company showed upon its books a large surplus accumulated prior to January 1, 1913, principally in the form of a debit against the Southern Pacific, which at the same time, as sole stockholder, was entitled to any and all dividends that might be declared, and being in control of the board of directors was able to and did control the dividend policy. The dividends in question were declared and paid during the first six months of the year 1914 out of this surplus of the Central Pacific accumulated prior to January 1, 1913; but the payment was only constructive, being carried into effect by bookkeeping entries which simply reduced the apparent surplus of the Central Pacific and reduced the apparent indebtedness of the Southern Pacific to the Central Pacific by precisely the amount of the dividends.

The question is whether the dividends received under these circumstances and in this manner by the Southern Pacific Company were taxable as income of that company under the Income Tax Act of 1913.²

The act provides, in section 2, paragraph A, subdivision 1 (38 Stat. 166), 'that there shall be levied, assessed, collected and paid annually upon the entire net income arising or accruing from all sources in the preceding calendar year' to every person residing in the United States a tax of 1 per centum per annum, with exceptions not now material. By paragraph G (a), p. 172, it is provided 'that the normal tax hereinbefore imposed upon individuals [1 per cent.] likewise shall be levied, assessed, and paid annually upon the entire net income arising or accruing from all sources during the preceding calendar year to every corporation * * * organized in the United States,' with other provisions not now material.

It is provided in paragraph G (b), as to domestic corporations, that such net income shall be ascertained by deducting from the gross amount of the income of the corporation (1) ordinary and necessary expenses paid within the year in the maintenance and operation of its business and properties, including rentals and the like; (2) losses sustained within the year and not compensated by insurance or otherwise, including a reasonable allowance for depreciation by use, wear and tear of property, if any, and in the case of mines a certain allowance for depletion of ores and other natural deposits; (3) interest accrued and paid within the year upon indebtedness of the corporation, within prescribed limits; (4) national and state taxes paid. It will be observed that moneys received as dividends upon the stock of other corporations are not deducted, as they are in computing the income of individuals for the purpose of the normal tax under this act (page 167), and as they were in computing the income of a corporation under the Excise Tax Act of August 5, 1909 (chapter 6, 36 Stat. 11, 113, § 38).

By paragraph G(c), the tax upon corporations is to be computed upon the entire net income accrued within each calendar year, but for the year 1913 only upon the net income accrued from March 1 to December 31, to be ascertained by taking five-sixths of the entire net income for the calendar year.

The purpose to refrain from taxing income that accrued prior to March 1, 1913, and to exclude from con- sideration in making the computation any income that accrued in a preceding calendar year, is made plain by the provision last referred to; indeed, the Sixteenth Amendment, under which for the first time Congress was authorized to tax income from property without apportioning the tax among the states according to population, received the approval of the requisite number of states only in February, 1913. Pollock v. Farmers' Loan & Trust Co., 157 U. S. 429, 581, 15 Sup. Ct. 673, 39 L. Ed. 759; Id., 158 U. S. 601, 637, 15 Sup. Ct. 912, 39 L. Ed....