Kelly v. Galloway

[EDITORS' NOTE: THIS PAGE CONTAINS HEADNOTES. HEADNOTES ARE NOT AN OFFICIAL PRODUCT OF THE COURT, THEREFORE THEY ARE NOT DISPLAYED.] In Banc. This is an appeal by the State Tax Commission from a decree of the circuit court in favor of the plaintiff, entered in a suit instituted by him against the commission to secure cancellation of a tax assessed by the commission against him under the Intangibles Income Tax Act (1931 Session Laws, p. 572, c. 335). In 1931 the plaintiff received from the Oregon Land and Livestock Company, of which he was a stockholder, the sum of $15,025 as part of a dividend against which the State Tax Commission levied the attacked tax of $1,202. The decree was entered after the defendants' demurrer to the complaint had been overruled. In 1931 the plaintiff received from the Oregon Land and Livestock Company, of which he was a stockholder, the sum of $15,025. This was part of a larger sum and the total came in the form of a dividend. He did not include in his return under the Intangibles Income Tax Act (1931 Session Laws, p. 572, c. 335) to the State Tax Commission the aforementioned sum of $15,025. The commission was aware of all of the circumstances, and the omission was not prompted by a dishonest purpose. Later, the commission assessed a tax upon this sum and the issue presented by this appeal is whether it was warranted in so doing.

Briefly stated, the facts as admitted by the demurrer to the complaint are: The plaintiff is now and for 30 years has been the owner of some shares of the capital stock of the Oregon Land and Livestock Company. In 1902 this corporation acquired large tracts of timberlands, and since that time has acquired small intermingling tracts. Apart from the purchase of these properties the corporation's sole activities have consisted of maintaining its existence, paying its taxes, protecting its lands, selling portions thereof as opportunities presented themselves, and distributing the proceeds to its stockholders. Prior to December 31, 1929, by common consent of all its stockholders and directors, it was agreed that the corporation "should engage in no business except such as was incidental to the protection of its properties and the sale and disposal thereof, and that as said properties were sold the proceeds thereof should be distributed among its members, and that whenever said assets should be completely disposed of said corporation should be dissolved." October 1, 1931, the corporation sold 4,838.67 acres of its land to the Pelican Bay Lumber Company for $355,047, $71,047 of which was paid at the execution of the contract and the balance was rendered payable in 12 equal annual installments with 6 per cent interest upon unpaid balances. January 8, 1929, it sold 37,538.75 acres of its land to the Ewauna Box Company for $2,133,158.96 of which $426,600 was paid at the execution of the contract and the balance was rendered payable in quarter annual installments of $50,000 with 6 per cent interest on unpaid sums. We now quote from the complaint: "In the year 1918 the major portion of the holdings of said corporation as then existing was sold * * * in the years 1928 and 1929 said corporation sold over 90 per cent of its remaining lands * * * said corporation had prior to January 1, 1930, sold and disposed of over 98 per cent of its holdings and to the extent that the proceeds of said sale had been received, had distributed the same among its stockholders."

In 1931 the corporation received $114,495.29 principal money and $15,180 interest money from its contract purchasers. In the same year it distributed in dividends to its stockholders all principal and interest money received since December 31, 1929, which had not theretofore been distributed. In this manner there was paid to the plaintiff in 1931 the aforementioned sum of $15,025, representing his part of the principal money received by the corporation. He reported to the defendants his share of the interest money, but not the $15,025.

The corporation's land increased greatly in value and it received from its vendees prices in excess of the cost of the property sold. The following is quoted from the complaint: "In making its return of income to the State of Oregon for the calendar year 1930 said corporation, on account of the aforesaid sales of said timberlands for sums largely in excess of the book value thereof, added to its then book surplus the profits upon said sales above the book value thereof and stated that it had a surplus of $1,792,477.57. * * *" Other facts averred in the complaint will be mentioned later.

From the Intangibles Income Tax Act of 1931, we quote:

"Section 2. * * * 9. The word ``intangibles' means and includes * * * all shares of stock in corporations, joint stock companies or associations.

"Section 3. A tax hereby is imposed upon every resident individual and corporation, which tax shall be levied, collected and paid annually at the rate of 8 per cent with respect to the taxpayer's net income as herein defined. * * *

"Section 7. The term ``net income' means the gross income of the taxpayer from intangibles less the deductions allowed by this act.

"Section 8. 1. The term ``gross income' includes all interest and dividends derived from intangibles as defined in section 2 of this act."

The principal contentions which the plaintiff advances are: Our Intangibles Income Tax statute is a tax upon income, and not one upon dividends, interest, etc. A surplus accumulated by a corporation prior to the enactment of the statute ought to be deemed capital and, therefore, a disbursement out of it ought to be deemed a nontaxable distribution of capital and not an ordinary course dividend. If the tax is construed otherwise its subject is not expressed in its title which states that the purpose of the act is to collect taxes "on incomes received from intangibles as herein defined". After directing attention to the averments of the complaint which state that the commission created by the 1923 income tax statute (1923 Session Laws, p. 410, c. 279) promulgated rules which declared that a dividend paid out of surplus existing at the time when the act went into effect was not taxable, he contends that when the legislature enacted the present statute in language similar to those rules, it intended that a similar interpretation be placed upon it. He contends that at one time the present commission construed the present act in manner similar to the 1923 commission, and that this purported interpretation is evidence of the meaning of the act. He argues that since the commission deems interest earned prior to the enactment of the statute, but paid subsequently, is not taxable, a holding that a dividend declared out of a previously existing surplus would violate Article I, § 32, Oregon Constitution, which provides that "all taxation shall be uniform on the same class of subjects," the provision of Article IX, § 1, which provides that taxation shall be levied under "uniform rules," and the equal protection clause of the 14th amendment to the federal constitution. Finally, he contends that only dividends declared in ordinary course by going corporations are taxable, and that the dividend which the plaintiff received in 1931 was a liquidating dividend.

Undoubtedly income and intangibles taxes are predicated upon a belief that taxes should be taken "from each according to his capacity". As expressed in the preamble to the statute under consideration, the intangibles tax is intended to exact from those who possess ability to carry a part of the tax burden a just contribution thereto. It accepts income and its components (dividends and interest) as proof of tax-paying capacity. It is difficult to determine exactly how much of a tax should be exacted "from each according to his capacity" because some possess an income of a permanent nature while others, who, like the plaintiff, have invested their funds in a single speculation, have a source of income only so long as the profits from the venture keep on coming in. It is not our duty, however, to undertake to revise the statute so as to render it just, if we believe that it is otherwise, but to give effect to the legislative will by placing upon the terms "income" and "dividends", the latter of which plaintiff believes is ambiguous, the meaning which the legislature intended so far as that meaning can be discovered. The law of taxation accepts from the law of corporations the distinction between the corporation and its stockholders. It regards them as separate persons. It will be observed that the intangibles income tax is not imposed upon the corporation which declares the dividend, but upon the stockholders who receive it. The tax is not levied upon any surplus which the stockholder or corporation owns, but is measured by the individual's income from his intangibles. The stockholder does not own the corporation's surplus. His rights therein are confined to the dividend, if any, paid out of it, and to the right to demand that a dividend be declared when it can be proved that such is the duty of the directors: Baillie v.Columbia Gold Mining Co., 86 Or. 1 (166 P. 965, 167 P. 1167). With these general observations in mind, let us turn to the authorities cited by the parties.

Since the tax imposed by the intangibles tax statute is not imposed upon the corporation, Doyle v. Mitchell Bros. Co.,247 U.S. 179 (62 L.Ed. 1054, 38 S.Ct. 467), and other similar decisions cited by the plaintiff, which construe the federal 1909 Corporation Excise Tax statute, are of but little assistance. The case just cited was an action by a corporation to recover from the collector additional taxes assessed under the statute just mentioned. The corporation was engaged in the manufacture of lumber from timber growing upon its land. It had acquired this land in 1903 at a price of $20 an acre, but, owing to improvement in the market, the land was worth $40 per acre December 31, 1908. In making its returns under the act, the company deducted from its gross receipts the enhanced market value of the stumpage as of December 31, 1908. The act levied a tax of 1 per cent upon "the entire net income over and above $5,000.00" received by corporations. In holding that the corporation properly made the above deduction, the court declared that the purpose of the act was to tax the conduct of corporate business according to its gainful activities from the time the act took effect. It regarded the timberlands as a part of the corporation's capital which the latter was entitled to value at its market worth on the day the law became effective. The court stated that the subsequent change in the form of this capital asset from timber into money did not change its nature as capital.

We dismiss the decision just reviewed and others like it as of but little assistance in determining the problem before us, and turn to Lynch v. Turrish, 247 U.S. 221 (62 L.Ed. 1087,38 S.Ct. 537); Lynch v. Hornby, 247 U.S. 339 (62 L.Ed. 1149,38 S.Ct. 543); Southern Pacific Co. v. Lowe, 247 U.S. 330 (62 L.Ed. 1142, 38 S.Ct. 540); Peabody v. Eisner, 247 U.S. 347 (62 L.Ed. 1152, 38 S.Ct. 546), which are cited in the briefs of both parties.

In Lynch v. Turrish, the facts were that March 1, 1913, the plaintiff was a stockholder in the Payette Company. Prior to March 1, 1913, this company had invested $1,375,000 in timberlands which on the day just mentioned were worth $3,000,000. The increase was due solely to market improvement. March 1, 1913, Turrish's stock was worth twice its par value. At that time all of the stockholders gave an option to sell their stock at double its par value. The optionee concluded to make the purchase but preferred to buy the assets of the corporation instead of the stock. The transaction was concluded in accordance with his preferences at a price which yielded to each stockholder twice the par value of his stock. At the time of payment each stockholder surrendered up his certificate of stock and received a sum double the par value of his stock. At the conclusion of this transaction the Payette Company had no property of any kind. The statute exacted a tax "upon the entire net income arising or accruing from all sources * * *. The net income of a taxable person shall include gains, profits * * * also from interest, rent, dividends * * *." In holding that Turrish's receipts from this transaction were nontaxable, the court regarded the transaction, not as the receipt of a dividend by Turrish, but as a sale of his stock. It pointed out that the amount received by him "manifestly was a single and final dividend in liquidation of the entire assets and business of the company, a return to him of the value of his stock upon the surrender of his entire interest in the company, and at a price that represented its intrinsic value at and before March 1, 1913, when the act took effect".

In Lynch v. Hornby, supra, the facts were that Hornby, from 1906 to 1915, was the owner of some shares of the capital stock of the Cloquet Lumber Company which for more than a quarter of a century had been engaged in purchasing timberlands, manufacturing the timber into lumber and selling the product. The company's capitalization was $1,000,000 divided into shares of $100 par value. On March 1, 1913, through increase in the value of the timberlands and other business operations, the value of the company's properties was $4,000,000 and Hornby's 434 shares were worth $150,000. In 1914 the company distributed dividends aggregating $650,000 of which $240,000 was derived from current earnings and $410,000 from conversion into money of timber owned March 1, 1913. Hornby's share of the sum just mentioned was $17,794, and he contended that it was nontaxable. This case was argued in the Circuit Court of Appeals with Lynch v. Turrish, supra. That court believed that the two cases were analogous and were controlled by the same principle of law. The United States Supreme Court felt otherwise. In holding that the sum last mentioned was subject to taxation under the federal 1913 income tax act, it declared:

"In our opinion it is distinguishable from the Turrish case, where the distribution in question was a single and final dividend received by Turrish from the Payette Company in liquidation of the entire assets and business of the company and a return to him of the value of his stock upon the surrender of his entire interest in the company, at a price that represented its intrinsic value at and before March 1, 1913, when the Income Tax Act took effect.

"In the present case there was no winding up or liquidation of the Cloquet Lumber Company, nor any surrender of Hornby's stock. * * * The operations of this company in the year 1914 were, according to the facts pleaded, of a nature essentially like those in which it had been engaged for more than a quarter of a century. * * * And we deem it equally clear that Congress was at liberty under the Amendment to tax as income, without apportionment, everything that became income, in the ordinary sense of the word, after the adoption of the Amendment, including dividends received in the ordinary course by a stockholder from a corporation, even though they were extraordinary in amount and might appear upon analysis to be a mere realization in possession of an inchoate and contingent interest that the stockholder had in a surplus of corporate assets previously existing. * * * We repeat that under the 1913 Act dividends declared and paid in the ordinary course by a corporation to its stockholders after March 1, 1913, whether from current earnings or from a surplus accumulated prior to that date, were taxable as income to the stockholder. * * * Of course we are dealing here with the ordinary stockholder receiving dividends declared in the ordinary way of business. Lynch v. Turrish and Southern Pacific Co. v. Lowe, rest upon their special facts and are plainly distinguishable."

In Southern Pacific Co. v. Lowe, supra, the facts were: The Southern Pacific Company was the owner of all of the stock of the Central Pacific Railway Company. Long before acquiring this stock it had obtained a lease upon all of the properties of the railway just mentioned which remained in effect after its acquisition of the stock. The Southern Pacific Company was in the actual physical possession of the Central Pacific and in charge of all of its operations. It acted as cashier and banker for the Central Pacific which had no bank account. As a result of these operations, there appeared upon the books of the Central Pacific Company a large surplus accumulated prior to January 1, 1913, principally in the form of a debit against the Southern Pacific Company. The latter company, as sole stockholder of the Central Pacific and in control of its board of directors, was able to and did control the dividend policy of the Central Pacific Company. In 1914 a dividend was declared by the Central Pacific Company out of this surplus, but its payment was carried into effect merely by bookkeeping entries which reduced the apparent surplus of the Central Pacific Company and reduced the apparent indebtedness of the Southern Pacific Company to the other railroad. The court held that this dividend was not taxable under the same act which was construed in the two preceding decisions. It is apparent from the decision that the court deemed the two corporations as one. It said:

"While the two companies were separate legal entities, yet in fact, and for all practical purposes they were merged, the former being but a part of the latter, acting merely as its agent and subject in all things to its proper direction and control. And, besides, the funds represented by the dividends were in the actual possession and control of the Southern Pacific as well before as after the declaration of the dividends. * * * Under the circumstances, the entire matter of the declaration and payment of the dividends was a paper transaction to bring the books into accord with acknowledged rights of the Southern Pacific."

The court made it clear that it did not deem the Southern Pacific as an ordinary stockholder. It said:

"But this is not the ordinary case. * * * Our view of the effect of this act upon dividends received by the ordinary stockholder after it took effect but paid out of a surplus that accrued to the corporation before that event, is set forth in Lynch v. Hornby."

To similar effect see Gulf Oil Corp. v. Lewellyn, 248 U.S. 71 (63 L.Ed. 133, 39 S.Ct. 35), upon which the plaintiff also relies. There the dividend declared by the subsidiary corporation in favor of the holding corporation was deemed as "bookkeeping rather than as ``dividends declared and paid in the ordinary course by a corporation'." See also 80 Penn. Law Rev. 892.

The facts in Peabody v. Eisner, supra, are: Peabody on and prior to March 1, 1913, owned 1,100 shares of the common stock of the Union Pacific Railroad Company, of the par value of $100 each. That company was the owner of large quantities of the corporate stock of the Baltimore Ohio Railroad Company. March 2, 1914, the Union Pacific declared and paid an extra dividend upon each share of its common stock amounting to $3 in cash and $34.50 in par value of stock of the Baltimore Ohio. In this manner Peabody received $3,300 in cash and 379 1/2 shares of Baltimore Ohio stock. In his income tax return for 1914 he included as taxable income $4.12 per share of Union Pacific dividend, contending that all of the balance of his receipts constituted a part of the surplus of the Union Pacific which it had accumulated prior to the enactment of the federal income tax statute. In holding that he was subject to a tax upon the entire dividend, the court declared:

"In this case the plaintiff in error stands in the position of the ordinary stockholder, whose interest in the accumulated earnings and surplus of the company are not the same before as after the declaration of a dividend; his right being merely to have the assets devoted to the proper business of the corporation and to receive from the current earnings or accumulated surplus such dividends as the directors in their discretion may declare; and without right or power on his part to control that discretion.

"It hardly is necessary to say that this case is not ruled by our decision in Towne v. Eisner, since the dividend of Baltimore Ohio shares was not a stock dividend but a distribution inspecie of a portion of the assets of the Union Pacific, and is to be governed for all present purposes by the same rule applicable to the distribution of a like value of money. It is controlled by Lynch v. Hornby, this day decided."

From Van Dyke v. Milwaukee, 159 Wis. 460 (146 N.W. 812, 150 N.W. 509), we quote:

"Are dividends declared and distributed during 1911 by a going mining corporation out of surplus on hand prior to January 1, 1911, when the income tax law went into effect, taxable as income for 1911? An affirmative answer must be given to this question, because the statute provides that ``there shall be assessed, levied, collected and paid a tax upon incomes received during the year ending December 31, 1911.' The plaintiff received this income during 1911. It was immaterial when it was earned by the corporation. As a stockholder he acquired no right to it until it was distributed in the form of a dividend. The profits of a corporation become income to stockholders when distributed as dividends, but not before."

See to like effect State ex rel. Sallie F. Moon Co. v.Wisconsin Tax Commission, 166 Wis. 287 (163 N.W. 639, 165 N.W. 470).

In Lapham v. Tax Commissioner, 244 Mass. 40, 138 N.E. 708, the plaintiff, a stockholder in the American-Hawaiian Steamship Co., sought the abatement of an income tax assessed upon a dividend paid to him by that corporation out of a surplus existing before the enactment of the statute. His complaint was dismissed. The facts, in addition to those already indicated, were: The company owned, among others, eight steamships which were carried on its books at a value of $2,986,466.19, but which had a market value on January 1, 1916, of $10,000,000. It sold seven of these vessels and recovered insurance upon the eighth when it was destroyed. In this manner the eight ships brought the company $11,461,562.22, or a profit of $8,475,098.03. At the conclusion of these transactions the company distributed in a dividend to its stockholders this entire profit, together with a large amount of other profits, but retained assets in excess of its liabilities and capital stock. The 1916 income tax statute of Massachusetts, after imposing a tax upon income, including income received in the form of dividends, provided:

"No distribution of capital, whether in liquidation or otherwise, shall be taxable as income under this section; but accumulated profits shall not be regarded as capital under this provision."

The court held that the plaintiff's portions of this dividend were taxable. We quote the following from the decision:

"The argument that the income is not taxable to the complainant under St. 1916 c. 269, § 7, now G.L., c. 62, § 7, because the increase in value of the property of the corporation came before January 1, 1916, is met by the decision to the contrary in * * *."

From these authorities — and we know of none to the contrary — it appears that a dividend declared and paid by a corporation in the ordinary course of its affairs while it is pursuing the business activities for which it was formed is deemed a part of the stockholder's income as the word "income" is defined in acts similar to ours, unless the stockholder is a corporation whose identity has become so merged with that of the other corporation that the two are really one. If, however, the corporation has abandoned its pursuits and has sold its property preparatory to terminating its existence, the sum which the stockholder receives upon surrender of his stock certificate will not be deemed a dividend but will be regarded as the sale price of his stock. We believe that these decisions indicate the interpretation which should be placed upon our act. As already stated, if the stockholder is not a corporation which has absorbed the dividend-declaring corporation, the two are regarded as separate entities. The surplus belongs to the dividend-declaring corporation and not to the stockholder. We remind ourselves that the tax is levied neither upon the surplus nor the dividend but upon the stockholder. The dividend is merely a measure by which the size of the tax is, in part, measured. Our statute interpreted in the light of the above decisions employs the term "dividend" in its ordinary and not in its technical sense. It does not expressly exclude a dividend paid out of a surplus. As ordinarily understood, a dividend is a dividend even though it is paid out of a surplus; likewise, as ordinarily understood, a liquidating dividend which is paid, incidental to the conclusion of the corporation's life, is not a dividend; it may be merely a return of capital. The plaintiff is apprehensive that if we apply to the word "dividend" as used in our act its common meaning liquidating dividends and stock dividends will be included. But taxation is a very practical matter, and we are satisfied that practical reasons will readily be found for excluding all forms of dividends from gross income which are not declared by going concerns in the regular course of business. The reasons expressed above persuade us that the mere fact that $15,025 of the plaintiff's 1931 dividend was paid out of a surplus existing before the Intangibles Income Tax Act of 1931 became effective did not render it nontaxable.

The question now occurs whether the distribution of this sum of money was a liquidating dividend. When this distribution was made the corporation was still transacting business in the same manner as it had done from its inception. Two per cent of its land remained unsold and a surplus, which a year previously amounted to $1,792,477.57, remained upon its books. December 31, 1929, this surplus was $496,949.12 after having been reduced by distributions made to the stockholders since 1902. The increase from the sum just mentioned to $1,792,477.57 was due, according to the complaint, "solely to the increase in the value of its holdings and the sales thereof aforesaid for sums in excess of the cost". The articles of incorporation are not before us, but the record indicates that the corporation was organized for the purpose of purchasing land, converting it into cash at an enhanced price, and distributing the proceeds to the stockholders. But in 1931 all of the land had not been converted into cash. Much of the conversion had not gone further than the contract stage. Apparently, it will be necessary to execute and deliver deeds to the purchasers when they have completed payment of the purchase price. So long as land remains unsold, deeds remain unexecuted and contracts remain unperformed, the time has not been reached when liquidation is possible. Thus in 1931 the corporation was actively engaged in business and the dividend declared in that year was not an extraordinary event, but was one performed in the ordinary course of the corporation's affairs. In Peabody v.Eisner, supra, and Lapham v. Tax Commissioner, supra, the dividends were paid out of surplus and reduced the latter materially; yet neither was deemed a liquidating dividend. Most corporations expect to replace the reduced surplus with new money derived from further earnings, but the mere fact that a corporation like this one does not expect to do so does not transform the dividend paid out of surplus into something else. Liquidation will be reached when the surplus is gone or the corporation proceeds to terminate its existence.

Commissioner of Internal Revenue v. Straub, 76 F.2d 388,Gossett v. Commissioner of Internal Revenue, 59 F.2d 365, and Anderson v. Burgess, 110 Or. 265 (223 P. 244), upon which the plaintiff relies, indicate that before a dividend can be regarded as a liquidating dividend the business of the corporation must have terminated and the corporation must be in the process of dissolution. In the first of these three cases the business which had been prosperous, but which had become a losing venture, was being wound up by the family which operated the corporation. In Gossett v. Commissioner of Internal Revenue, supra, the stockholders had authorized the sale of the mills owned by the corporation preparatory to winding up its affairs. Out of the sale price a 50 per cent dividend was declared, followed shortly by another which required the surrender of the certificates of stock. The decision held that these dividends were liquidating dividends, pointing out:

"Certainly at the time of payment of the dividend in question [that is, the first] the corporation was not a going concern in the legal sense as its dissolution was already under way. * * * The record shows that it was a very unusual dividend, and entirely outside of the due course of the business of the corporation."

In Anderson v. Burgess, supra, the contract of dissolution stated that the corporation "is this day dissolved by mutual consent".

It is our belief that the 1931 dividend was not a liquidating dividend. We believe that the statute contemplates that this dividend should be included in the stockholder's return.

We do not believe that when the word "dividend" is construed in the above manner any unwarranted discrimination exists between one whose income is derived from interest and another whose income is dependent upon dividends, even though the commission does not require that interest earned before the act took effect, but not paid until after that time, should be included in the taxpayer's return. The shareholder has no property right in the corporation's funds before a dividend is declared, but in behalf of the holder of an interest-bearing obligation a debt is accruing in the hands of his obligor which he can enforce at the appropriate time. This difference is recognized in the daily transaction of dealing in securities. A bond is sold for its market price plus accrued interest, whereas a share of stock is sold at its market price with nothing added on account of a prospective dividend. In other words, the two groups of individuals have classified themselves and the adoption of this classification by the legislature cannot be deemed unreasonable.

It is true that the tax commission created by the 1923 income tax statute promulgated rules with which our above-indicated interpretation is not in harmony. We also observe from the complaint that one of the defendant commissioners in a letter to the plaintiff interpreted our present act in a manner different from the above. These administrative interpretations are important and helpful, but not controlling. We have given them careful consideration. Our interpretation of the act, however, is indicated in the foregoing paragraphs.

The above, we believe, is sufficient to indicate our disposition of the several contentions advanced by the plaintiff. It follows that, in our opinion, the circuit court erred when it overruled a demurrer to the complaint and also when it entered a decree in favor of the plaintiff. The decree is reversed. Costs and disbursements will not be allowed.

BEAN, C.J., and BAILEY, KELLY and RAND, JJ., concur.

CAMPBELL and BELT, JJ., did not participate.