James v. Commissioner , 13 B.T.A. 764 ( 1928 )

ARTHUR CURTISS JAMES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

James v. Commissioner

Docket No. 2509.

United States Board of Tax Appeals

13 B.T.A. 764; 1928 BTA LEXIS 3192;

October 3, 1928, Promulgated

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">*3192 1. Where a parent company owns all the stock of its subsidiary companies, in determining the source of profits or earnings of the parent company available for distribution to the stockholders, within the contemplation of section 201 of the Revenue Act of 1918, the earning of the subsidiaries should be considered only to the extent to which they have been distributed as dividends to the parent company.

2. Where in 1918 the parent corporation received dividends from a subsidiary corporation, a portion of which was paid from earnings and profits accumulated since February 28, 1913, and the balance from other sources, held, that the distributions made by the subsidiary to the parent from sources other than earnings accrued subsequent to February 28, 1913, represent, for the purposes of the income tax, a return to it of a part of its investment and do not constitute earnings available for distribution to stockholders where there is no gain in excess of cost or March 1, 1913, value.

3. When it is necessary, in determining the source from which distributions to stockholders are made, to prorate the net earnings of the year, the Federal income and profits taxes for the taxable">*3193 year are properly deducted in computing the earnings of the year. L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135, distinguished.

4. In computing the earnings of a corporation available for distribution under the Revenue Act of 1918, the date of payment is controlling.

5. Liberty bonds received from a corporation, as part of a dividend, should be valued at their market value when received.

Robert E. Coulson, Esq., and Oscar W. Underwood, Jr., Esq., for the petitioner.

John D. Foley, Esq., and Joseph K. Moyer, Esq., for the respondent.

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PHILLIPS

">*764 This proceeding is for the redetermination of a deficiency in income taxes for the calendar year 1918 amounting to $353,025.16. Petitioner alleges that the respondent erred in determining that certain dividends received by him from the Phelps Dodge Corporation were distributions made from earnings accumulated after February 28, 1913, subject to tax as dividends and in determining the value of certain Liberty bonds received as a part of such dividends. Substantially all of the facts were stipulated.

FINDINGS OF FACT.

The petitioner is an individual, a citizen of the United">*3194 States, and resides in the State of New York. He has at all times kept his books of account upon the cash receipts and disbursements basis, and at all ">*765 times rendered his Federal income-tax return upon such basis and upon the calendar year basis.

The petitioner was, during the year 1918, a stockholder of Phelps Dodge Corporation and during the year 1918 received certain distributions from said corporation, as hereinafter set forth. The Phelps Dodge Corporation was a corporation having outstanding during 1918 only one class of stock, namely, common stock, and of said total outstanding stock of the Phelps Dodge Corporation, the petitioner, throughout 1918, owned 33,64377 per cent. The petitioner duly filed, on May 15, 1919, his income-tax return covering the calendar year 1918, as required by the Revenue Act of 1918. All of the items in said return are true and correct, except the item or items relating to distributions received by the petitioner during the year 1918, which are the subject of this controversy, an item of $332.11, representing tax paid at the source on certain bonds, and an item of $1,262,302.78 covering charitable, religious and educational contributions">*3195 made by the petitioner during 1918. At least $1,000,000 was contributed by petitioner during 1918 to religious, charitable and educational corporations, no part of the earnings of which inured to the benefit of any private stockholder or individual.

The Phelps Dodge Corporation is a corporation organized and existing under the laws of the State of New York, having been incorporated in 1885 under the name of Copper Queen Consolidated Mining Co. In 1917, pursuant to the applicable provisions of the law of New York, its name was changed to Phelps Dodge Corporation.

The Phelps Dodge Corporation, throughout the year 1918, owned all of the outstanding capital stock of Moctezuma Copper Co., Phelps Dodge Merchantile Co., Dawson Fuel Sales Co., Bunker Hill Mines Co., and Commercial Mining Co., and, subsequent to April 30, 1918, the Phelps Dodge Supply Co. The Phelps Dodge Corporation, the Moctezuma Copper Co., Phelps Dodge Mercantile Co., Dawson Fuel Sales Co., Bunker Hill Mines Co., Commercial Mining Co., and Phelps Dodge Supply Co., at all times, including the year 1918, kept their books of account and rendered their tax returns strictly upon the accrual basis of accounting and consistently">*3196 and at all times accrued upon such books of account for each calendar year, including the taxable year 1918, all taxes for such calendar year, including estimated Federal income and excess-profits taxes, imposed on the basis of the earnings for such calendar year, although such taxes were not payable until the succeeding calendar year, and in determining their earnings and profits available for distribution to stockholders for each calendar year, including the year 1918, deducted as an expense of operation the Federal income and excess-profits ">*766 taxes accruing on account of their operations for such calendar year even though not paid until the succeeding calendar year.

For the year 1918, the Phelps Dodge Corporation filed a consolidated income-tax return with Moctezuma Copper Co., Phelps Dodge Mercantile Co., Dawson Fuel Sales Co., Bunker Hill Mines Co., Commercial Mining Co., and Phelps Dodge Supply Co., under a ruling by the Commissioner of Internal Revenue that all of such corporations were affiliated for the purposes of section 240 of the Revenue Act of 1918. Neither the Phelps Dodge Corporation, Moctezuma Copper Co., nor Phelps Dodge Mercantile Co. kept their books">*3197 in such manner as to show earnings or profits for the accounting periods within which distributions were made by them, but all of them, and the Dawson Fuel Sales Co., Bunker Hill Mines Co., Commercial Mining Co., and Phelps Dodge Supply Co., kept their books in such manner that their earnings were determinable or determined only upon an annual basis and at the end of each year. The total income and profits tax for such consolidated group for the calendar year 1918 was $4,383,013.98, and the said total tax was apportioned to the several said corporations as follows:

Phelps Dodge Corporation	$3,167,693.00
Moctezuma Copper Co	974,991.81
Phelps Dodge Mercantile Co	238,136.10
Dawson Fuel Sales Co	1,302.07
Phelps Dodge Supply Co	$891.00
Bunker Hill Mines Co	00.00
Commercial Mining Co	00.00
	4,383,013.98

The earnings and profits, individually, of each of the following corporations, for the calendar year 1918, before reduction and after reduction of the same by the proportionate parts of the said tax of $4,383,013.98, were as follows:

	Before reduction	Tax	After
	by tax		reduction by tax
Phelps Dodge Corporation	$13,580,104.81	$3,167,693.00	$10,412,411.81
Moctezuma Copper Co	3,199,497.58	974,991.81	2,224,506.77
Phelps Dodge Mer. Co	781,459.90	238,136.10	543,323.80
Dawson Fuel Sales Co	4,271.85	1,302.07	2,969.79
Phelps Dodge Supply Co	2,923.87	891.00	2,032.87
Bunker Hill Mines Co	1 59,923.67	None.	1 59,923.67
Commercial Mining Co	None.	None.	None.

">*3198

The earnings shown above for Phelps Dodge Corporation include dividends received by that corporation from its subsidiaries during the calendar year 1918, as follows: (1) From Phelps Dodge Mercantile Co., $650,000, being the entire distributions of said subsidiary during 1918; and (2) from Moctezuma Copper Co., $2,688,370.71, being that part of the dividends and distributions, amounting to a total of $3,120,000, as set forth below, of said subsidiary during ">*767 1918, which were paid from earnings and profits during 1918 and earnings and profits accumulated since February 28, 1913, and does not include $431,629.29 which was paid from sources other than earnings and profits accumulated since February 28, 1913.

The earnings and profits accumulated since February 28, 1913, and on hand January 1, 1918, of each of the following corporations, were as follows:

Phelps Dodge Corporation	$838,503.14
Moctezuma Copper Co	463,863.94
Phelps Dodge Mercantile Co	382,359.52
Dawson Fuel Sales Co	$26,535.48
Bunker Hill Mines Co	None.
Commercial Mining Co	None.

The Phelps Dodge Supply Company was organized April 30, 1918.

The Phelps Dodge Mercantile">*3199 Co. made distributions of $650,000 to the Phelps Dodge Corporation, as its sole shareholder, by dividends declared, payable and paid during 1918, as follows:

Date of declaration	Date of payment	Amount
Mar. 13, 1918	Mar. 28, 1918	$150,000
June 12, 1918	June 27, 1918	250,000
Sept. 12, 1918	Sept. 28, 1918	100,000
Dec. 12, 1918	Dec. 31, 1918	150,000
		650,000

The Moctezuma Copper Co. made distributions to the Phelps Dodge Corporation during 1918 of $3,120,000, by distributions declared, made payable and paid as follows:

Declared	Payable and paid	Amount
Mar. 13	Mar. 28	$650,000
June 12	June 27	650,000
Sept. 12	Sept. 28	780,000
Dec. 12	Dec. 31	1,040,000
		3,102,000

During the year 1918 the dividends by the Phelps Dodge Corporation were declared, were payable by the corporation and were received by the petitioner, and were reported in the petitioner's income-tax returns as follows:

Date	Date payable	Amount of	Amount received	Amount reported
declared	and received	dividend	by petitioner	in return
Mar. 14	Mar. 29	$3,600,000	$1,211,176	$1,211,176
June 13	June 28	2,700,000	908,382	605,588
Sept. 12	Sept. 30	3,600,000	1,211,176	908,382
Dec. 12	Jan. 2, 1919	3,600,000
		13,500,000	3,330,734	2,725,146

">*3200 ">*768 The Commissioner determined that the amount of $3,330,734 received by the petitioner was paid from earnings and profits accumulated after February 28, 1913, and computed the deficiency accordingly.

The dividend of September 11, 1918, was declared to the extent of $2,700,000 in cash and $900,000 in the face amount of Liberty bonds. The petitioner received on September 30, 1918, $908,426 in cash and Liberty bonds of the face amount of $320,750, and the fair market value of said Liberty bonds so received by the petitioner on the date received was $285,190.50. The dividend of December 12, 1918, was declared to the extent of $2,700,000 in cash and $900,000 face amount in Liberty bonds. Of this distribution there were payable to and were received by the petitioner on January 2, 1919, $908,426 in cash and $302,750 face amount of Liberty bonds, which amount of Liberty bonds had a fair market value on the date so received of $289,277.63. The Liberty bonds so distributed by the corporation to its stockholders were purchased by the corporation at par.

The distributions made by Phelps Dodge Corporation to the petitioner during the taxable year 1918, from sources other than">*3201 earnings and profits accumulated since February 28, 1913, did not exceed the fair market price or value as of March 1, 1913, of stock of Phelps Dodge Corporation acquired by petitioner before March 1, 1913, and/or the cost of stock of Phelps Dodge Corporation acquired by petitioner subsequent to March 1, 1913, and held by him during the calendar year 1918, after applying all proper credits in reduction of such March 1, 1913, value and/or cost basis.

OPINION.

PHILLIPS: The respondent determined that the dividends received by the petitioner in 1918 from Phelps Dodge Corporation were paid entirely from earnings accrued subsequent to February 28, 1913, and subject to surtax. At the time this determination was made and the deficiency letter mailed to the petitioner, the earnings of that corporation for the year had not yet been finally determined by the Commissioner. Subsequently these earnings were determined to be the amounts shown above, and in order to sustain the deficiency asserted against this petitioner it became necessary for the respondent to urge three contentions, each of which is contrary to the position taken by the respondent in his regulations and rulings in other">*3202 cases, as follows:

(1) That the earnings and profits of the subsidiaries of Phelps Dodge Corporation not paid over to the parent corporation are available for distribution to its stockholders within the contemplation of section 201 of the Revenue Act of 1918.

">*769 (2) That in determining the amount of earnings and profits available for distribution to stockholders of Phelps Dodge Corporation under section 201 of the Revenue Act of 1918, distributions made by Moctezuma Copper Co., a subsidiary, to Phelps Dodge Corporation in 1918 in excess of the earnings and profits of Moctezuma Copper Co. accumulated since February 28, 1913, ought to be included.

(3) That Federal income and profits taxes for 1918 are not a properly accruable expense in determining the earnings and profits of Phelps Dodge Corporation available for distribution to its stockholders under section 201 of the Revenue Act of 1918.

(1) The petitioner alleges and the answer admits that it is the consistent and well-established administrative practice of the respondent, in making determinations as to the source of the funds from which distributions are made, under section 201(b) of the Revenue Act of 1918">*3203 and corresponding sections of subsequent acts, to consider as part of the earnings or profits of the parent company the earnings or profits of the subsidiary only to the extent that such earnings or profits of subsidiaries are actually paid over to the parent company by way of dividends or otherwise during the accounting period in question. Counsel for respondent urge that since Phelps Dodge Corporation owned all of the capital stock of its subsidiaries, the general rule which has been consistently followed by the Commissioner does not apply; that we should disregard the corporate entities and, under Southern Pacific Co. v. Lowe,247 U.S. 330">247 U.S. 330, and Gulf Oil Corporation v. Lewellyn,248 U.S. 71">248 U.S. 71, hold that all earnings of the subsidiary were available for distribution to the stockholders of the parent concern and that the dividends were in contemplation of law paid in part from the undistributed earnings of the subsidiary. We do not believe that the decisions cited go to the extent urged by counsel. The court made it clear that those cases turned upon their special facts. One of such facts, which is absent here, was that the earnings in question">*3204 accrued prior to the effective date of the Constitutional amendment and were to all intents and purposes in the possession and control of the parent corporation before such date so as to constitute, in substance, a part of its capital on that date; furthermore, the amounts in question were not ordinary dividends but extraordinary in character and amount. See Lynch v. Turrish,247 U.S. 221">247 U.S. 221, and Lynch v. Hornby,247 U.S. 339">247 U.S. 339, decided on the same date as 247 U.S. 330">Southern Pacific Co. v. Lowe, supra, in which the court notes a distinction between ordinary and recurrent dividends and dividends in the nature of a distribution of capital assets, although such assets may represent earnings of prior years. If we were inclined to construe these decisions as holding that the earnings of the subsidiaries were income to the parent when earned to the extent that they could not thereafter constitute income to the parent, it would still be necessary to take one further step and hold ">*770 that such earnings were so completely the property of the parent that they could be used by it to pay dividends to its stockholders. We are not willing">*3205 either to so construe these decisions or to take the additional step which would be required. The earnings of the subsidiaries should be considered only to the extent to which they have been distributed as dividends to the parent company.

(2) During 1918 the Phelps Dodge Corporation received $3,120,000 in dividends from the Moctezuma Copper Co. A portion of that amount was paid to the Phelps Dodge Corporation from earnings and profits accumulated by the Copper Company since February 28, 1913, and the balance was paid from sources other than earnings and profits accumulated since February 28, 1913.

Counsel for the Commissioner apparently contended at the hearing that in determining the earnings of the Phelps Dodge Corporation accrued subsequent to February 28, 1913, we should include the total amount of the dividend of the subsidiary, whatever he source might be. This position is contrary to that heretofore taken by the respondent. See Treasury Decision 3499; also the opinion of the Attorney General dated June 21, 1923. This contention was not urged in the brief filed by counsel.

The distributions made by the subsidiary to the parent in 1918 from sources other than earnings">*3206 accrued subsequent to February 28, 1913, are to be regarded for tax purposes as in the nature of a return to the parent of a part of the amount invested or of the March 1, 1913, value of its investment and are not a part of the earnings or profits of the parent; at least until there is a gain to the parent by reason of a return to it of amounts in excess of the cost or March 1, 1913, value of the stock. We do not have presented the question whether in the latter case such dividends could still be distributed to the stockholders of the parent free from tax. In the present proceeding there should be included in the earnings of the Phelps Dodge Corporation for 1918 only so much of the dividends paid by the Moctezuma Copper Co. as represented distributions from earnings accrued after February 28, 1913.

(3) In connection with the third question raised, counsel for respondent points out that we have held that the invested capital of a corporation may not be reduced, in determining the extent to which a dividend is paid from current earnings of a year, by a "tentative" tax theoretically set aside out of such earnings prorated over such year (">*3207 L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135), and suggests that we might wish to apply a similar rule in determining the amount of earnings available for distribution, although expressly refraining from urging that we should do so. In that case we were concerned with computations of the invested capital of corporations, which is purely a statutory concept. In construing the statutory definition of invested ">*771 capital, we held that earnings of the current year available for dividends should not be decreased on account of an estimated tax later to accrue, on the ground that to do so would be to take into account in the computation of invested capital an element of expense or outgo of the current year, while forbidden bythe statute to offset that element by the income of the year. In this proceeding, we are not concerned with the statutory concept of invested capital, but must determine the amount of earnings and profits of the Phelps Dodge Corporation which were available for distribution to stockholders on the date of distribution. Since the earnings to each of these dates is unknown, the Commissioner is compellled to ascertain the earnings for the entire year and">*3208 prorate them. Applying the reasoning of the court in United States v. Anderson,269 U.S. 422">269 U.S. 422, we are of the opinion that the Federal income and profits taxes for 1918 are properly to be deducted in determining the earnings and profits of the year.

The parties are also unable to agree whether the date of declaration or the date of payment is to control in computing the earnings available for distribution. Following the decision of the court in Mason v. Routzahn,275 U.S. 175">275 U.S. 175, the Board decided in Emily D. Proctor,11 B.T.A. 235">11 B.T.A. 235, that the situation under the Revenue Act of 1918 was the same as that presented to the court under the Revenue Act of 1917, and that the date of payment controlled.

At the hearing, petitioner conceded that there should be added to his taxable income for the year 1918, as shown by his return, the amount of $18,750, received as dividends from the United Verde Extension Mining Co. which petitioner had treated in his return as nontaxable. The Commissioner and the petitioner conceded at the hearing that an item of $332.11, representing tax withheld at the source, should be added to the taxable income">*3209 of the petitioner as shown by his return, and the same item of $332.11 deducted from the total tax payable by the petitioner on the basis of the recomputation of its income as shown by the evidence in this proceeding.

It appears that in computing petitioner's income the Commissioner included at their par value the Liberty bonds received from the Phelps Dodge Corporation as a part of the dividend. At the hearing counsel conceded that these bonds should have been valued at their market value when received.

Reviewed by the Board.

Decision will be entered under Rule 50.

STERNHAGEN and ARUNDELL dissent.

GREEN

GREEN, dissenting: The revenue acts provide that after the earnings and profits accumulated by a corporation subsequent to February 28, 1913, have been distributed, the earnings and profits accumulated ">*772 prior to March 1, 1913, are, upon distribution to its stockholders, tax exempt. In the case here under consideration the stockholder was a corporation and the question is whether the tax-exempt dividends received by it are tax exempt in the hands of its stockholders when distributed.

">*3210 In the Appeal of Caroline S. McLean,4 B.T.A. 487">4 B.T.A. 487, following the rule laid down in Lynch v. Hornby,247 U.S. 339">247 U.S. 339, we said:

A dividend is none the less income to the stockholder though a distribution of earnings accumulated by the corporation prior to March 1, 1913, and is taxable in the absence of express statutory exemption.

In that case we also said:

The provisions in the 1916 and subsequent acts exempting such dividends do not have the effect of changing their fundamental nature and converting into capital that which was income.

Prior to the adoption of the majority opinion herein I had thought this question settled. In that opinion, however, it is said:

The distributions made by the subsidiary to the parent in 1918 from sources other than earnings accrued subsequent to February 28, 1913, are regarded for tax purposes as in the nature of a return to the parent of a part of the amount invested or of the March 1, 1913, value of its investment and not as a part of the earnings or profits of the parent; at least until there is a gain to the parent by reason of a return to it of amounts in excess of the cost or Mach 1, 1913, value of">*3211 the stock.

The rule thus announced is predicated upon the theory that that which was received by the stockholder of the subsidiary corporation was not income, and to me it seems that such a rule is contra to that announced in 247 U.S. 339">Lynch v. Hornby, supra, and the 4 B.T.A. 487">Appeal of McLean, supra.

In the prevailing opinion it is said:

The earnings of the subsidiaries should be considered only to the extent to which they have been distributed as dividends to the parent.

This I believe to be a correct statement of the law. The parent corporation here had no interest in the earnings of its subsidiary until distributed, for as was said in Rhode Island Hospital Trust Co. v. Doughton,270 U.S. 69">270 U.S. 69, "The owner of shares of stock in a company is not the owner of the corporation's property." If the Hornby and McLean cases, supra, are right, it follows that all that the subsidiary distributed as dividends to the parent was income (in part tax exempt) to the parent in the year in which the dividend was paid.

If the dividends of the subsidiary are income to the parent corporation, the case falls squarely within section 201(b) ">*3212 of the Revenue Act of 1918, which reads as follows:

(b) Any distribution shall be deemed to have been made from earnings or profits unless all earnings and profits have first been distributed. Any distribution ">*773 made in the year 1918 or any year thereafter shall be deemed to have been made from earnings or profits accumulated since February 28, 1913, or, in the case of a personal service corporation, from the most recently accumulated earnings or profits; but any earnings or profits accumulated prior to March 1, 1913, may be distributed in stock dividends or otherwise, exempt from the tax, after the earnings and profits accumulated since February 28, 1913, have been distributed.

Such income to the parent corporation may not be said to have been "accumulated before March 1, 1913," and may not therefore be distributed by it tax exempt for it is only earnings and profits accumulated prior to that date which may be so distributed.

Ordinarily those attempting to support the rule announced in the majority opinion urge that once income is impressed with the exemption, it retains its exempt status thereafter. Such an argument leads to the conclusion that if the subsidiary">*3213 distributes a depletion or depreciation reserve, or income from tax-exempt bonds, such distribution may be, by the parent, distributed tax exempt. The same rule should apply in all cases and it should be held that exempt income is not ear marked and that it is not so impressed with the exempt status that its recipient may distribute it tax free.

Under the regulations and the later revenue acts, the basis to be used in the computation of gain or loss on sale or other disposition of the stock is reduced by the amount of the tax-exempt distribution. If the majority rule is put into effect, a peculiar advantage results to the stockholder of the parent corporation in that he receives the pre-March 1, 1913, earning of the subsidiary tax exempt and at the same time his corporation has the same advantage, offset it is true, by the reduction in basis. Surely such a result was not within the contemplation of Congress, and that is the test, for the exemption is not inherent but is a matter solely within the power of Congress. See ">*3214 247 U.S. 339">Lynch v. Hornby, supra.

In my opinion the dividends distributed to petitioner herein by the parent corporation are not tax exempt and are in no wise affected by the fact that the funds from which they were paid were received by the parent corporation tax exempt.

SMITH, LOVE, and MORRIS agree with this dissent.

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Footnotes

• 1. Deficit. ↩