Berliner v. District of Columbia

258 F.2d 651

• Court: Court of Appeals for the D.C. Circuit
• Decided: May 1, 1958
• Docket: Nos. 14024-14028
• Status: Published

Opinions

WASHINGTON, Circuit Judge.

These cases arise under the income tax laws of the District of Columbia. They present the question whether amounts distributed in complete liquidation of a corporation, to the extent that those amounts exceed the cost of the stock and represent corporate earnings, are properly includible in the stockholders’ gross income as a dividend under Section 47-1551c(m) of the District of Columbia Code (1951).

In 1937 the petitioners became common stockholders in the Engineering & Research Corporation (“Erco”), each paying to the company the full par value for his or her shares. On November 15, 1954, Erco sold its assets and business to ACF Industries, Inc. (“ACF”), for $3,000,000,¹ realizing a profit of $2,196,-371.46 on the sale. On that date Erco had an earned surplus of $613,628.54, a substantial part of which represented earnings in 1954. Following the sale the profit of $2,196,371.46 also was reflected in and became a part of its earned surplus account. In December of 1954 Erco distributed to its common stockholders, pro rata on the stock owned by each, the cash and the ACF stock acquired on the sale of assets, reserving only the amounts required to retire its preferred stock and to pay liabilities not assumed by ACF. It was stipulated that, after excluding the amount of capital included in the distribution,² the remainder was paid out of surplus acquired from operating profits up to November 15, 1954, and surplus acquired from the proceeds of the sale of its business to ACF. Erco charged the distribution, after excluding the capital, to earned surplus; it had no paid-in or capital surplus.

In their 1954 income tax returns to the District of Columbia, the petitioning stockholders reported the distribution as a sale or exchange of their stock, a capital asset, resulting in a non-taxable gain. Deficiencies for 1954 were assessed against them, computed by including in taxable income as a dividend under Section 47-1551e(m) of the Code the amount distributed by Erco in complete liquida-dation, less an amount representing return of capital.³ The taxpayers paid the taxes so assessed and petitioned for refunds. The District of Columbia Tax Court approved these assessments and denied refunds of the taxes so paid. The present petitions followed.

Section 47-1557a(a) of the Code includes “dividends” within the definition of gross income. Section 47-1551c(m) defines a dividend as—

“any distribution made by a corporation (domestic or foreign) to its stockholders * * *, out of its earnings, profits, or surplus (other than paid-in surplus), whenever earned by the corporation and whether made in cash or any other property * * * and whether distributed prior to, during, upon, or after liquidation or dissolution of the corporation: * * ⁴

It was stipulated in writing before the Tax Court that the distribution, to the extent taxed, was paid out of surplus, and the evidence showed that Erco had only earned surplus, to which the distribution was charged. The taxpayers make no contention to the contrary here.⁵ The distribution made by Erco, during or upon its liquidation, was thus out of “its earnings, profits, or surplus,” earned in part from operations and in part on the sale of its assets in 1954. As such, it falls precisely within the statutory language and the imposition of the tax was required.

The correctness of this view is confirmed, by reference to the history of the related Federal taxing provisions.⁶ Corn-mencing with the Revenue Act of 1916,⁷ c. 463,39 Stat. 757 (1917), a dividend was defined generally as any distribution out of earnings and profits accumulated after February 28, 1913,⁸ with certain additions not relevant here, and this definition has continued until the present time.⁹ The 1918 Act, the 1924 Act (but not the 1921 Act), and all subsequent acts including the present Code,¹⁰ provide specifically that amounts distributed in complete liquidation of a corporation shall be treated as in full payment in exchange for the stock. Under such specific provisions a liquidating distribution is treated as the proceeds of an “exchange” resulting in gain or loss to the stockholder-recipient, even though the distribution may include corporate earnings and profits, and even though without the specific provision the broad definition of dividends would include distributions in liquidation. See Hellmich v. Hellman, 1928, 276 U.S. 233, 236-237, 48 S.Ct. 244, 72 L.Ed. 544; White v. United States, 1938, 305 U.S. 281, 59 S.Ct. 179, 83 L.Ed. 172; Helvering v. Chester N. Weaver Co., 1938, 305 U.S. 293, 59 S.Ct. 185, 83 L.Ed. 180. But in the Revenue Acts of 1916, 1917, and 1921 there was no such specific provision as to the treatment of distributions in complete liquidation. In cases governed by those acts it has been uniformly held that distributions in liquidation, whether partial or complete, fell within the definition of a dividend to the extent that they represented accumulated earnings, and thus were properly taxable as a dividend.¹¹ The holdings under the 1921 Act are especially significant: they construed the general definition of a dividend unequivocally to include distributions of earnings in a liquidation, where the specific provision of the 1918 Act that distributions in liquidation are to be treated as paid in exchange for the stock was omitted from the 1921 Act. See particularly Commissioner of Internal Revenue v. Sansome, supra, note 11, 60 F.2d at page 932 and McCaughn v. McCahan, supra, note 11, 39 F.2d at page 4.

The District statute contains virtually the same definition of a dividend as the Federal statutes have contained since the 1916 Act, with the significant addition that in the District statute Congress included a specific provision that the term “dividend” includes a distribution of earnings “during, upon, or after liquidation.” ¹² Had Congress intended that such a distribution be treated as an exchange, we think it would have omitted the reference to liquidating distributions in the definition of a dividend and would have included a provision similar to that which has appeared in the Federal statutes uninterruptedly since 1924. We must therefore reject the taxpayers’ contention that the transaction should be held to be an exchange, the gain from which is excluded from gross income by Section 47-1557a(b) (11).¹³

The petitioners recognize that the statutory definition of a dividend is broad enough to include the liquidating distributions to them, after capital is excluded. But, petitioners argue, the statutory language should not be applied literally here to tax as a dividend the part of the distribution which represents earnings, because to do so would lead to results not intended by Congress. The foregoing discussion demands rejection of this argument. We note, however, that Congress was undoubtedly cognizant that either method of treatment might present some problems in application, cf. Magill, The Income Tax Liability of Dividends in Liquidation, 23 Mieh.L.Rev. 565, 566-568 (1925), and that it purposely selected the method of taxing liquidating distributions of earnings as dividends for purposes of the District tax. The wisdom of such a choice is obvious, when the provisions of the District law relating to capital gains (D.C.Code, §§ 47-1551c(i) and 47-1557a(b) (11)) are considered. If distributions like the present were treated as sales or exchanges of stock, as taxpayers argue they should be, some stockholders (those who had owned their stock for more than two years) would escapo tax altogether on receipt of the corporate earnings whereas other stockholders would be taxed in full on receipt of exactly the same distribution of earnings merely because they had held their stock for only two years or less. Such a difference in treatment for the same distribution would hardly be justified by logic — and, as we read the statutes, Congress has not authorized it. The argument that the distributions “grew out of” the ownership of stock would be equally applicable to any distribution of earnings, including dividends in the ordinary course paid by corporations not in liquidation, and is hardly persuasive as a reason for holding these distributions not within the literal statutory language.

Finally, the taxpayers contend that the Fifth Amendment prohibits taxation as dividends of amounts distributed in liquidation to the extent that they represent corporate earnings. Their argument is two-fold: that to do so taxes the stockholder on the earnings of another entity, the corporation, and that it arbitrarily and capriciously provides a different treatment from that afforded stockholders who sell their stock to third persons. The first point, if accepted, would prohibit the taxation of any distribution of corporate earnings to a stockholder as a dividend. But, of course, the point cannot be accepted. Cf. United States v. Phellis, 1921, 257 U.S. 156, 169, 42 S.Ct. 63, 66 L.Ed. 180. In respect of the taxpayers here the argument overlooks the fact that the distributions not only returned to them their capital investments in full but also a substantial additional amount as a gain or profit. The question is whether the Fifth Amendment permits Congress to tax this profit as dividend income, when it also represented a distribution of corporate earnings. The courts have frequently recognized that a distribution of earnings in liquidation may rationally be treated as a dividend as well as an exchange.¹⁴ It was constitutionally open to Congress to elect to tax the profit as a dividend for purposes of the District tax, just as it was constitutional for it to do so for purposes of the 1921 Federal Act. Commissioner of Internal Revenue v. Sansome, supra, note 11, 60 F.2d at page 932. Cf. Neild v. District of Columbia, 1940, 71 App.D.C. 306, 110 F.2d 246.

To be sure, this method of taxation provides a different treatment from that accorded to stockholders who sell their stock to third persons. But such a sale does not involve a distribution by the corporation of its earnings and capital in liquidation, and has no element of a dividend, unlike the distributions here.¹⁵ It thus cannot be thought to be unreasonable or arbitrary to treat sales of stock to third persons as sales and to treat distributions in liquidation as dividends to the extent that earnings are included— although such considerations are probably not relevant for purposes of the Fifth Amendment. Neild v. District of Columbia, supra, 71 App.D.C. at pages 318-320, 110 F.2d at pages 258-260.

Affirmed.

1 . This amount was paid in substantial part in cash; the balance was made up by the issuance of 10,000 shares of ACF stock, valued at the stock’s market value on the date the contract was closed. In addition to the payment of $3,000,000 for the assets, ACF assumed all of Erco’s liabilities, with the exception of certain items specifically excluded by the sale contract.

2 . I. e., an amount equal to the original capital paid in (the par value of their common stock) by the stockholders.

3 . See footnote 2.

4 . A proviso to this section reads as follows :

“Provided, however, That in the case of any dividend which is distributed other than in cash or stock in the same class in the corporation and not exempted from tax under this article, the basis of tax to the recipient thereof shall be the market value of such property at tile time of such distribution. * * * ”

The only part of the dividend here involved which was distributed other than in cash was stock of AOF (not common stock of Erco), which was valued at its market value on the date of distribution as the proviso directs. Taxpayers have pointed out no provision of the income tax law, and we know of none, which exempts a dividend paid in property other than cash or stock of the same class in the paying company, here stock of another company, from tax. Taxpayers do rely on the provisions exclud-

ing from gross income the gains on sales or exchanges of capital assets, which will be discussed infra. Suffice it to say here that such exclusion provisions do not relate to the exemption, from tax of the type of dividend referred to in the proviso.

5 . Such a contention would* not be sustainable. There was a gain by the corporation on the sale of its assets. For Federal tax purposes that gain may not have been taxable (cf. Int.Rev.Code of 1954, § 337(a) and (b), 26 U.S.C.A. § 337(a, b)), and if not recognized as taxable income would not be regarded as increasing Erco’s earned surplus by virtue of a specific statutory enactment (Int.Rev. Code of 1954, § 332(f) (1), 26 U.S.C.A. § 312 (f) (1)). But the District statute has no such provision as to the effect on earned surplus. Furthermore, we are not advised as to the status of the gain for District corporate income tax purposes. If the assets sold had been held for more than two years and if they were not stock in trade or inventoriable properties or lield primarily for sale to customers in the ordinary course of the corporation’s business, they would be capital assets as defined in D.C.Code, § 47-1551c(Z) and would be excluded from the statutory definition of gross income by D.C.Code, § 47-1557a(b) (11). The corporation’s balance sheet on the date of sale showed very substantial inventories so that at least a substantial part of the assets sold were not capital assets of the corporation, as defined by statute, and would have been within the broad definition of income contained in D.C.Code, § 47-1557a(a). Cf. Commissioner of Internal Revenue v. Court Holding Co., 1945, 324 U.S. 333, 65 S. Ct. 707, 89 L.Ed. 981; Eisner v. Macomber, 1920, 252 U.S. 189, 207, 40 S.Ct. 189, 64 L.Ed. 521. If some part of the assets sold were within the definition of capital assets of the corporation, which the evidence docs not show, and thus were excluded from its income by the statutory definition of gross income, the gain allocable to such part would nevertheless probably be regarded as increasing its earned surplus account in the absence of a statutory provision or regulation to the contrary. Cf. Commissioner of Internal Revenue v. F. J. Young Corp., 3 Cir., 1939, 103 F.2d 137; Commissioner of Internal Revenue v. Wheeler, 324 U.S. 542, 65 S.Ct. 799, 89 L.Ed. 1166, rehearing denied 1945, 325 U.S. 892, 65 S.Ct. 1182, 89 L.Ed. 2004; 1 Mortens, Law of Federal Income Taxation, §§ 9.32 and 9.38 (1956). In any event, the stipulation as to the source of the distribution makes such considerations unnecessary here.

6 . See generally 1 Mertens, Law of Federal Income Taxation, §§ 9.63, 9.64, 9.66, 9.87, 9.88, and 9.89 (1956) ; Darrell, Corporate Liquidations and the Federal Income Tax, 89 U. of Pa.L.Rev. 907-909 (1941).

7 . Section II, snbd. B of the Revenue Act of 1913, c. 16, 38 Stat. 167 (1915), the first act after adoption of the Sixteenth Amendment, included “dividends” in gross income without attempting to define them. Lynch v. Turrish, 1918, 247 U.S. 221, 38 S.Ct. 537, 62 L.Ed. 1087, and Lynch v. Hornby, 1918, 247 U.S. 339, 38 S.Ct. 543, 62 L.Ed. 3149, were decided under this Act. Read together, they seem to indicate that the Court construed the word “dividends” in that Act as referring to dividends paid in the ordinary course and as not including amounts distributed in complete .liquidation of a corporation. But such a construction is not controlling here, where the statutory provisions are different.

8 . March 1, 1913, was the effective date of the first revenue act following ratification of the Sixteenth Amendment.

9 . See Int.Rev.Code of 1954, § 316(a), 26 U.S.C.A. § 316(a).

10 . Int.Rev.Code of 1954, § 331(a) (1), 26 U.S.C.A. § 331(a) (1).

11 . Under 1916 Act: A. B. Nickey & Song, 1925, 3 B.T.A. 173.

1917 Act: James Dobson, 1925, 1 B.T.A. 1082; cf. Vincent v. McLaughlin, 9 Cir., 1932, 61 F.2d 657, petition for certiorari dismissed 1933, 288 U.S. 618, 53 S.Ct. 508, 77 L.Ed. 990.

1921 Act: Commissioner of Internal Revenue v. Sansome, 2 Cir., 60 F.2d 931, certiorari denied sub nom. Sansome v. Burnet, 1932, 287 U.S. 667, 53 S.Ct. 291, 77 L.Ed. 575; Phelps v. Commissioner, 7 Cir., 1931, 54 F.2d 289, certiorari denied 1932, 285 U.S. 558, 52 S.Ct. 458, 76 L.Ed. 946; Leland v. Commissioner, 1 Cir., 50 E.2d 523, certiorari denied 1931, 284 U.S. 656, 52 S.Ct. 34, 76 L. Ed. 557; McCaughn v. McCahan, 3 Cir., 1930, 39 F.2d 3; Hamilton Woolen Co., 1930, 21 B.T.A. 334; Frank D. Darrow, 1927, 8 B.T.A. 276; cf. Holmquist v. Blair, 8 Cir., 1929, 35 F.2d 10.

12 . See Section 47-1551c(m), above quoted. Tbe provision with which we are here concerned wag enacted in 1947. Previously, the 1939 tax act defined the word “dividend” as “any distribution made by a corporation out of its earnings or profits * * * ”, and provided:

“It includes such portion of the assets of a corporation distributed at the time of dissolution as are in effect a distribution of earnings.” See D.C.Code, § 47-1543(16) (Supp. V, 1956).

The change in the 1947 Act seems to us-to have been adopted to eliminate the necessity of a finding that a distribution is “in effect” a distribution of earnings, when some of the assets distributed represent earned surplus.

13 . It is here relevant to note that if these distributions are considered to bo “gains from the sale or exchange of any capital asset,” as defined in D.C.Code, §§ 47-1557a (b) (11) and 47-1551c(Z), they would escape District tax entireiy. This is in contrast to the Federal statutes which do not exempt capital gains but tax them in a special way. See Int.Rev. Code of 1954, § 3201 et seq. 26 U.S.C.A. § 1201 et seq.

14 . See, e. g., cases cited in footnote 31; Hellmich v. Hellman, 1928, 276 U.S. 233, 48 S.Ct. 244, 72 L.Ed. 544; Magill, supra, 23 Mieh.L.Rev. at pages 566-568.

15 . We do not think that the same could necessarily be said of a sale of stock back to the issuing corporation itself. It may be that in some circumstances such a sale would amount to a partial (or even a complete) liquidation. We make no comment as to tile possible tax consequences of a sale by the stockholders of all ERCO stock to another corporation, such as ACF.