Petition for Writ of Certiorari — Crane-Johnson Co. v. Helvering

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IN THE

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Supreme Court of the United States

October Term, 1939.

CRANE-JOHNSON COMPANY, a corporation

of North Dakota,

Petitioner,

Vv.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES CiRCUIT COURT OF APPEALS

FOR THE EIGHTH CIRCUIT.

JOHN E. HUGHES,

First National Bank Bldg.,

Chicago, Illinois, ;

Counsel for Petitioner.

4

U. 8. Law Printing Company, 2817 N. Halsted St., Chicago, Ill.

INDEX.

Page

Petition for writ of certiorari to the Circuit Court of

Appeals for the Fighth Circuit:

ne NN en ueeeineoids 2

Tg et et tt LO UC NOG EE SPEND ES 2

Questions: Presented fk. 2

Statutes and Regulations Involved... 3

Statement sevsssnseeeeieeceeeennusaceseeneeentennnnnsesecteetecennenaseeseeneeennents 4

Specification of Errors to Be Urged... cece. 8

Reasons for Granting the Writ... eee nee 8

Brief in Sepport.of Petitica 12

Opinions Below ........... LEAL A Le IRE LOR OIA 12

0 ES RELI Weert Se MA Se RO Re 12

Questions presented, statutes and regulations in- -

GEES TENTS ROE AEs NORCO ERE IS ek LOD 12

Specification of errors to be urged......... Se NS 12

Point I. The charter of a corporation is a written

contract executed by the corporation...................... 12

Point Il. The provisions of the general corporation

law of North Dakota which are written and ex-

pressly deal with the payment of dividends, are .~

as much a part of said charter contract as if they

were set forth therein mes cae) ae

Point III. The stock certificate of the corporation

constitutes a written contract executed by it un-

BN OU sina pecans damssrrcrensaecgreaisanremscosepiccottneateeralencudee 15

Pe

Point IV. The written provisions of the state law

expressly dealing with the payment of dividends

are as much a part of the stock certificate as if

they were set forth verbatim therein...

Point V. Petitioner’s charter contract expressly

forbade it to declare a dividend in 1936...

Point VI. Imposition of the surtax on ineome which

is not distributable violates both the taxing stat-

ute and the Fifth Amendment...

4

Print VII. The decision below discriminates against

the petitioner in favor of others similarly situ-

ated in violation of the Fifth Amendment...

Point VIII. The legislative history and intent and

spirit of the statute support petitioner...

CITATIONS.

Cases:

Chenanso Bridge Co. y. Binghampton Bridge Co.,

oe ee ee iS SEES IES Fa

Cochran v. Commissioner, 78 F. (2d) 176, 179 (C."

silted NG RNAS a Sel AR SON Ue ees Me ee |

Culbertson’s, In re, 549F. (2d) 753, 757 (CC. A. 9)

Dartmouth College v. Woodward (1819), 4 Wheaton

Pa Rae te Oe OO

Edwards v. Douglas, 269 U. S. 204, 214

Hadden v. Commissioner, 49 F. (2d) 709 ct:

SP | gente

18

19

20

24

iil

Hanson’s Estate, In re, 159 N. W. 399, 58 So.

Dak. 1 sichissiaiiidieadibbincasidiidbe acct sindlammadtaedie 14

Hassett v.. Welch, 303 U. S. 302, 314.0000. eee 16

Home Building & Loan Assn. v. Blaisdell, 290 U. S.

398, 429, 430...............-.. DERM HAI ANN Wg oO 12, 14

Helvering v. Bliss, We Nic Ge 2 Bent eccoininnines ee |

Helvering v. Canfield, 291 U. Sa 163, 166.0000... 18-19

Jones v. Mo. Edison Elec. Co.,,144 Fed. 765, 770... 15

Johnston, In re, 33 B. T. A. 551, 563.2... 17

Kelly Springfield Tire Co. v. United States, 81 F.

| eR. SRR RM ROME ORD ATO VeRO oem 17

Lynch v. United States, 292 U. S. 571, 577.....0.2....... 14

Old Colony Trust Company v. Commissioner, 301 .

U. &. 379, 383........ oscaieeblabesaeSbisnecedigianseou Slledetesasess 17

Personal Industrial Bankers v. Citizens Budget Co.,

FY. (20) i, See tC. GA. Chk... 12

Roche’s Beach, Ine. v. Commissioner, 96 F. (2d)

+40, 470 tC. ©. Ay Finn. li dcesiadesgdecaliec acetates 17

Sanford v. Commissioner, 106 F. (2d) 882, 884........ 24

Ulness v. Dunnell, 61 N. D. 95; 237 N. W. 208...... 18

United States v. Jim Fuey Moy, 241 U. S. 394, 401 22

United States v. Merchants National Trust & Sav-

ings Bank, 101 F. (2d) 399, 404 (C. C. A. 9)...... 17

United States v. Quincy, 4 Wallace 535 14

Willeuts v. Milton Dairy Co., 275 U. S. 215, 218. 19

Yoakam v. Providence Biltmore Hotel Co., 34 F.

| Beatin Mennienee oe 15

~~

BUA i BEEN ait

iv

TEXT BOOKS AND REFERENCES.

36 Columbia Law Review, p. 1343... ptiaiseabecteadae 13, 15

Cook on Corporations a Sees. 492-494... 12

/

Corporations, 14 C. J., See. —, me 12

Congressional Record, Vol. 80, Part 8, p. 9058.......... 22, 23

Vol. 1, Fletcher’s Encyclopedia on Corporations, p.

4409 See. 226.0. ptesieteielsabincieastbaseblionduendoncssckudearecs 14

50 Harvard Law mrriew, 300, 301. 15

House Report No. 2475, 74th Cong., 2nd Sess:.......... 24

Indiana Law Journal By Dy peteoencccratinsa 13

XII Indiana Law Review acetate en 7

I. T. 3152, C. B. 1938-1, Hill RERUTS ieee Rees Se eM 16

Law of Federal Income Taxation, Paul & Mertens,

Vol. III Supplement, Sec. 32 A430 13

Senate Hearings, pp. 265-268... 24

Senate Report 2156, 74th Cong., 2nd Sess., pp. 12,

Bip FIPS csinti ences } PERNT Seg I SEN to 17

North Dakota Compiled Laws—Suppiement—( Ann.)

be 2. pera : ; 3

Revenue Act of 1936 (U. S. C. Supp. ITI, Title 26,

See. 13a):

See. 14 (a) (2), (b) : J 3

See. 26 (¢) (1)...... PEN Sy a ade Set EM Sas 4,5,2

See. 27 (h)......... ‘ eimiscnaees 20

Tréasury Regulations 94 (1936 Ed.) 4

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IN THE

Supreme Court of the United States

October Term, 1939.

CRANE-JOHNSON COMPANY, a corporation

~ of North Dakota,

Petitioner,

v.

: a

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES CIRCUIT COURT OF APPEALS

FCR THE EIGHTH CIRCUIT.

a

The Craae-Johnson Company, a corporation of North

Dakota, by John E. Hughes, its attorney, prays that a

Writ of Certiorari issue to review the judgment of the

United States Circuit Court of Appeals for the Eighth

Cireuit entered in the above-entitled cause on August 8,

1939, affirming a decision of the United States Board of

Tax Appeals. rn

OPINIONS BELOW.

The opinion of the Board of Tax Appeals is published

in 38 B. T. A, 1355. The opinion of the Circuit Court of

Appeals is published in 105 F. (2d) 740.

JURISDICTION.

The judgment below was entered August 8, 1939, and a

Petition for Rehearing was denied September 15, 1939 (R.

46). The jurisdiction of this Court is invoked under Sec-

tion 240 (a) of the Sudicial Code as amended by the Act

of February 13, 1925.

QUESTIONS PRESENTED.

Whether, for the purpose of the credit permitted in the

determination of the surtax on undistributed profits un-

der the Revenue Act of 1936, the taxpayer’s charter con-

stitutes ‘‘a written contract executed by the corpcration,

which contract expressly deals with the payment of divi-

dends’’? If not, whether the taxpayer’s stock certificates

‘ constitute a written contract executed by the corporation

| which contract expressly deals with the payment of

} dividends?

+ Is the law, as construed by the Court below, so arbi-

trary and capricious that it violates the Fifth Amendment,

in classifying the petitioner with others not similarly situ-

ated and in discriminating against the petitioner in favor

H of others who are similarly situated?

| To put the question more concretely, the taxpayer’s

income for 1936 was $13,450.76. It had a capital deficit of

$21,251.40. Under North Dakota statutes it could declare

| dividends only from ‘‘surplus prefits’’. There was no

| surplus but instead an impairment of capital stock. Since

it was expressly prohibited by North Dakota statute from

distributing any dividend-and since the statute constituted

a part of its charter and since the charter was a written

contract with the State and its stockholders, taxpayer

contends that it was prohibited by the provisions of a

written contract expressly dealing with the payment of

dividends, from declaring any dividend during the taxable

year and hence is literally within the words of the Rev-

enue Law allowing a credit against the undistributed

profits tax. The same is true of taxpayer’s stock cer-

tificate.

STATUTES AND REGULATIONS INVOLVED.

North Dakota Compiled Laws—Sunplement—( Anno-

tated), 1913-1925:

**Sec. 4543. Dividends, only from profits: limitations

of indebtedness; exceptions—The directors of corpo-

Tations must not make dividends except from the sur-

plus profits arising from the business thereof: nor

must they divide, withdraw, or pay to the stockhold-

ers, or any of them, any part of the capital stock.***”’

REVENUE ACT OF 1936

(U. S. C. Supp. ITI, Title 26, Sec. 13a):

“Sec. 14. Surtax on Undistributed Profits.

(a) Definitions—As used in this title—

+

* ”

(2) The term ‘undistributed net income’ means

the adjusted net income minus the sum of the divi-

dends paid credit provided in section 27 and the

eredit provided in sectiun 26 (c), relating to con-

tracts restricting divide. ds.

(b) Imposition of Tax— There shall be levied, col-

lected, and paid for each axable year upon the net

income of every corporation a surtax equal to the

sum of the following, subject to the application of the

specific credit as proviced in subsection (c):

7 per centum of the portion of the undistributed

net income which is not in excess of 10 per centum

of the adjusted net income.

* * = 99

— . : 9 ist he ea a

Ce ee oe

4

“Sec. 26. Credits Of Corporations. In the case of

a corporation the following credits shall be allowed

to the extent provided in the various sections im-

posing tax—- 7

* * *

(c) Contracts Restricting Payment of Dividends.—

(1) Prohibition on Payment of Dwidends.—An

amount equal to the excess of the adjusted net income

over the aggregate of the amounts which can be dis-

tributed within the taxable year as dividends without

violating a provision of a written contract executed

by the corporation prior to May 1, 1936, which pro-

vision expressly deals with the payment of divi:

dends.’’

Treasury Regulations 94 (1936 Ed.), promulgated un-

der the Revenue Act of 1936.

‘**The charter of a corporation does not constitute

a written contract executed by the corporation within

the meaning of 26 (e).”’

STATEMENT.

The facts in this case were stipulated (R. 12) and the

Board found the facts as stipulated (R. 14). It was stipu-

lated that petitioner was incorporated under the statutes

of North Dakota, April 29, 1903. That as of January 1,

1936, petitioner had a deficit of at least $21,251.40. There

was a surplus in March 1930 (R. 12)

Petitioner’s net income from the taxable year was

$13,450.76 (R. 12-13). Its adjusted net income was

$12,032.72 (R. 13, 14). The Statute of North Dakota ex-

pressly forbade its directors to declare any dividend. In

its return for 1936 it claimed a credit under Section 26

i. It was stipulated that the records prior to January 1, 1929 are

not susceptibie of analysis to show how the deficit occurred buty since

there was no deficit in March 1930 and the deficit occurred gubse-

quent to that date, it is immaterial whether the records prior to the ~

time there was a surplus are susceptible of analysis,

IRN REDO AOD Roe BE AOE ERA Tg lh

(c) (1) of the Revenue Act of 1936 in the computation of

the su:tax on undistributed profits. The Commissioner

disallowed this credit, determined a surtax of $1771.36 on

undistributed profits, and asserted a deficiency in that

amount (R. 12, 13). The Board of Tax Appeals approved

the action of the Commissioner (R. 21-22) and this action

was affirmed by the Circuit Court of Appeals (R. 41).

In addition to the other income taxes (a normal tax of

from 8 to 15% and an excess profits tax from 6 to 12%)

Congress by the Revenue Act of 1936 imposed a special

undistributed profits surtax of from 7 to 27%°on the por-

tion of earnings which corporations did not distribute as

dividends to their stockholders.

It was recognized that in certain cases corporations

could not distribute dividends and in such cases a credit

was allowed. The provision allowing the credit and which

the petitioner claims is applicable in this case is the pro-

vision of 26 (c) (1) of the Revenue Act of 1936 allowing |

a credit in the following language:

*‘An amount equal to the excess of the adjusted net

income over the aggregate of the amounts which can

be distributed within the taxable year as dividends

without violating a provision of a written contract

executed by the corporation prior to May 1, 1936,

which provision expressly deals with the payment of

‘. dividends.’’

In the case at bar petitioner’s adjusted net income was

$12,032. 17-and since its capital impairment was $21,251.41

there was no excess of adjusted net income which could

be distributed as dividends without violating its charter

contract and hence we contend its case falls literally with-

in the above quoted statute and it is entitled to the credit

thereby allowed.

It was conceded below and must be conceded here that

if petitioner’s charter constitutes a written contract exe-

cuted by petitioner cortaining a provision which expressly

deals with the payment of dividends, then the decision of

the Court below was wrong and petitioner is entitled to

the credit. The same is true if its stock certificate con-

stituted such a contract. ,

Since petitioner’s charter was executed prior to May 1,

1936, the first question in this case is whether it is ‘‘a

written contract executed by the corporation prior to May

1, 1936”? and if so whether it contains a provision which

“expressly deals with the payment “of dividends”.

Petitioner claims that its charter,is a written contract

between its stockholders, itself and’ the State, that this

charter consists among other things of the express provi-

sions of the State Corporation Law as fully as if it were

repeated verbatim therein and that the provision of this

State Law which the charter contract contains ‘‘expressly

deals with the payment of dividends”. Hence petitioner is

entitled to the credit allowed by the above provision of

the Revenue Act and is literally within it. * * * Moreover.

to deny such credit in this case is to discriminate against

the petitioner in favor of other taxpayers which are sub-

ject to restrictive contracts and therefore similarly situ-

ated with respect to the payment of dividends, in viola-

tion of the Fifth Amendment.

Petitioner further claims that the surtax on undistrib-

uted profits is framed upon the premise that the income

to be taxed shall be distributable by the taxpayer corpo-

ration, and that it is.a violation not only of the taxing law

but of the Fifth Amendment to impose the surtax on its

income which was not distributable.

+

apes

Spee.

Ain

% 7

The regulation promulgated under: the 1936 Revenue

Act expressly declared that a charter would not be con-

sidered a written contract within the above-quoted pro-

vision of the law. This regulation, however, has not been

approved by the re-enactment of the Statute because the

short experience under the undistributed profits tax

proved it a failure and it was not re-enacted. Shortly

after its promulgation the regulation was questioned by

disinterested academic sources. XII Indiana Law Review

19, 28; 36 Columbia Law Rev. 1343.

The Board of Tax Appeals held in this case that irre-

spective of whether the charter was a contract expressly

dealing with the payment of dividends, Congress did not

intend to embrace it within this provision of the law, be-

wens Revenue Act of 1936, as it passed the House,

contayfied a provision giving relief to ALL deficit corpo-

ratiois and this provision was omitted from the confer-

ence draft that became law. However there is nothing in

the legislative history showing why it was omitted. Peti-

tioner argued in the Circuit Court of Appeals that this

holding was erroneous for the reason that if legislative

history could be considered, the provision contained in the

Héuse Bill granted relief to ALL deficit corporations, in-

eluding those existing in States where they might legally

declare dividends and the Senate considered this too broad

and therefore struck it out, evidently considering that

corporations restricted by charter or other contracts

from declaring dividends, alone should have relief. (See

page 23 annexed brief.) The Circuit Court of Appeals

affirmed but on entirely different grounds than that upon

which the Board put its decision (R. 41).

The Court held that the North Dakota Statute quoted

on page 3 hereof mde it the cbligation of the Directors

and not of the corporation not to declare dividends (R.

CAE RSE GAIN OEE Sehcs SPALL AINE GAAS Er le ahaa

.

an 23 ce < | cl

43) and that ‘‘the corporation itself has made no written

contract affecting its right to declare dividends’’.? ‘The

opinion seems to hold that the charter is a written con-

tract and again that it is not a written contract (R. 43).

Again the Court seems to say that merely because a pen-

alty is imposed on the directors the obligation is theirs

alone and not that of the corporation.

The Court did not pass on the contention that the stock .

certificate was such a contract, although this contention

was urged by petitioner. The Court also stated that if

there was such contract it was implied, overlooking that

the contract upon which we rely is all in writing.

SPECIFICATION OF ERRORS TO BE URGED.

Tke Cireuit Court of Appeals erred:

(1) In failing to hold that petitioner was prohibited

from distributing any of its 1936 earnings as dividends

because of the provision of the” Written contract executed

by it prior to May 1, 1936, which provision expressly deals

with the payment of dividends.

(2) In affirming the order of the Board of Tax Appeals..

(3) In failing to hold that the-statute as construed by

it was so arbitrary and unreasonable that it violated the

Fifth Amendment.

REASONS FOR GRANTING THE’ WRIT. |

The question presented’ by the present case is an im-

portant question of federal income tax law and one of —

wide general importance, not heretofore determined by.

2. In another part of its opinion the Court said (R. 42): “The

Supreme Court of North Dakota has held that a dividend cannot be

rightfully declared by a corporation except out of the profits earned

by it and that this princivle is embodied in the North Dakota Statutes

above referred to. Wlness v. Dunnell, 237 N. W. 208.”

ot.

this Court and which should be determined by this Court.

The question affeets alf corporations in the United States

which had an impairment of capital stock in 1936 and

which made any profit in that year. Scores of cases in-

volving this question from all over the country are pend-

ing in the Treasury Department before the Board of Tax

Appeals and some in the Federal District Courts. It is

impossible for there to be a conflict between the United

States Cireuit Courts of Appeal at this time because this

is the first and only case decided by a Circuit Court |

of Appeals which involves this question. Other taxpayers

similarly situated are unwilling to accept the decision of

the Court below as sound law and have expressed an

intention to continue to litigate their cases and are con-

tinuing to litigate them and unless th? question is settled

by this Court now, erent expense will be imposed upon

the Government and taxpayers in future litigation in-

volving this question, other petitions for tertioragi pre-

senting it will be filed and in all probability its settlement

by this Court will be merely postponed.

Furthermore, it is submitted the Court below has de-

cided the very important question presented in an unten-

able way, because it is elementary law that, the charter

of the corporation is a written contract embracing among

its terms the provisions of the State Statutes and the

Statates of North Dakota, as construed by the Supreme

Court of the State, expressly prohibited the petitioner

declaring dividends. Thus by provision in writing ex-

pressly dealing with the payment of dividends, which was

a part of its charter, petitioner was restrained from pay-

ing the same. The same is true of petitioner’s stock

certificates.

)

~ \

“\

rts id |

The decision is further untenable because it gives no

consideration to the underlying purpose, reason and intent

of the statute and fails to attempt to reconcile this under-

Bate: intent with the construction which it gives the

statute. The construction of the Court below~imputes to

Congress an intent to make an indefensible discrimina-

tion by allowing rich corporations to avoid the tax, while

affording no escape to those in failing circymstances—

and this for no reason whatever®

Furthermore, it is submitted the construction adopted

by the Court below results in violation of the Fifth

Amendment. The law hy its terms necessarily purports

to levy a surtax on income which can be distributed by

the taxpayer corporation to its stockholders. Under the

construction adopted by the Court below, however, this

characteristic of the tax is ignored and no distinction

made between distributable and undistributable income,

although this taxpayer and numerous other corporations

similarly situated could not.in fact or in law treat their

earnings, if distributed, as income distributable to their

stockholders by way of taxable dividends, but only as

return of capital. ‘The petitioner is therefore arbitrarily

classified with corporations which can distribute their in-

come and are therefore in a materially different situation.

Moreover, the interpretation adopted by the Circuit

Court of Appeals permits a righ and prosperous corpora-

tion to escape the surtax, provided it happens to have

executed a contract restricting payment of dividends,

while it does not permit corporations with an impairment ~

of capital stock and on the verge of bankruptcy to escape

the tax, notwithstanding they are equally disabled from

3. Ce ap: Foley Securities Co. y, Commissioner, 106 F. (2d)

731, 785

——

11

distributing their earnings, thus clearly and needlessly

resulting in a most arbitrary and unfair discrimination

between taxpayers subject to substantially the same dis-

ability. ° ‘

The reasons why the important decision below is un-

tenable are briefly developed in the annexed brief.

Wherefore it is respectfully submitted that this Petition

should be granted. -

JOHN E. HUGHES,

First National Bank Bldg.,

Chicazs, Illinois,

Attorney for Petitioner.

Sere ete

12

4

<a>

; BRIEF IN SUPPORT OF PETITION.

—=

. A statement of the jurisdiction of this Court, a state-

ment of the case and the assignment of errors are set

forth in the foregoing petition and not repeated here. It

is submitted that the following points, all of which are

elementary and undisputed law, clearly sustain the peti-

tioner’s case. ad

POINT I.

THE CHARTER OF A CORPORATION IS A WRiTTEN

CONTRACT EXECUTED BY THE CORPORATION.

Among the multitude of authorities so holding see,

Dartmouth College v. Woodward (1819), 4 Wheaton 518

(17 U. 8. 418), 682-683; Home Building & Loan Assn. v,.

Blaisdell, 290 U. §. 398, 429, 430; Corporations, 14 C. J.,

Sec. 162, page 161; 7 Ruling. Case Law, Sec. 71, p. 93;

Cook on Corporations (8th Edition), Secs. 492-494; Per.

sonal Industrial Bankers v. Citizens Budget Co., 80 F.

(2d) 327, 328 (C. C. A. 6th).

Between the decision in the Dartmouth College a,

and the decision in the Home Building & Loan Assn. case, ‘

numerous decisions of this Court have repeated the doc- ;

trine. In Chenango Bridge Co. v. Bunghampton Bridge

Co., 70 U. S. 51, at page 73, the Court said:

‘We have supposed, if anything was settled by an

unbroken course of decisions in the federal and state

courts, it was, that an Act of incorporation was a

contract between the State and the stockholders. All

courts at this day are estopped from questioning the

doctrine. The security of property rests upon it, and

every successful enterprise is undertaken, in the un-

shaken belief that it wil never be forsaken.

‘A departure from it now would involve dangeks to

society that cannot be foreseen, would shock the sense

of justice of the country, unhinge its business inter-

-

13

esis, and weaken, if not destroy, that respect which

has always been felt for the Judicial Départment of

the Government. An attempt even to reaffirm it, could

only tend to lessen its force and obligation.”’

We do not multiply citations but all text books and

innumerable decisions of lower federal Courts and of all

state Courts have uniformly repeated as elementary law

the rule for which we contend. It is a fixed legal principle

which was well known to members of Congress.

In the article on the Undistributed Profits Tax in XII

Indiana Law Journal 19, at p. 28, apropos of the section

of the income tax law involved here, it is said:

‘‘That the charter of a corporation is a contract

was determined long ago in the famous Dartmouth

College case, and the charter in the case of the In-

diana corporation contains provisions which ‘ex-

pressly deal with the payment of dividends.’ This

_would seem a sufficient compliance with the require-

ments of Subsection 26 (c) (1) of the Act to entitle

the corporation to credit when it is prevented from

paying dividends by the terms of its charter.’’

In the article in 36 Columbia Law Review, page 1343,

it is said:

‘“‘The Treasury has excluded corporate charters

from the category of contracts thereby repudiating

the traditional definition of a charter as a contract

between state and corporations’’.

Also the charter is a contract executed by the corporation.

See the collection of authorities in the Law of Federal

Income Tazation, Paul & Mertens, Vol. I1I Supplement,

Sec. 32:443.*

4. One thing the Legislative History of the Act conclusively

shows is that Congress attached no special importance to the word

“executed’’. The Ways and Means Committee referred to a ‘“‘written

contract in existence prior to March 3, 1936”. (See Ways and

Means Committee Report 2475, 74th Congress, 2nd Session, page 8.)

(Boldface ours.) The Senate Finance Committee referred to con-

tracts ‘“‘entered inte prior to March 3, 1936”. (Finance Committee

Report No. 2156, 74th Congress, 2nd Session, p. 12.) (Boldface

ours.) For a definition of the word “executed”, see 28 C. J. p. 278.

Both the charter and the stock certificates are executed contracts

within the meaning of this definition.

“rr

14

POINT II.

THE PROVISIONS OF THE GENERAL CORPORA.

TION LAW OF NORTH DAKOTA WHICH ARE

WRITTEN AND EXPRESSLY DEAL WITH THE

PAYMENT OF DIVIDENDS, ARE AS MUCH A

PART OF SAID CHARTER CONTRACT AS IF THEY

WERE SET FORTH THEREIN.

Among the many authorities so holding, see, Ainsworth

v. Southwestern Drug Co., 95 F. (2d) 172, 173 (C. C. A.

5th}; Vol. 1, Fletcher’s Encyclopedia on Corporations, p.

_ 440, Sec. 226; Home Building & Loan Assn. v. Blaisdell.

290 U. S. 398, 429, 430; In re Hanson’s Estate, 159 N. W.

399, 38 So. Dak. 1.

In United States v. Quincy, 4 Wallace 535, the (Court

said:

“It is also settled that the laws which subsist at

the time and place of the making of a contract, and

where it is to be performed, enter into and form a

part of it, as if they were expressly referred to or

incorporated in its terms. This principle embraces

alike those which affect its validity, construction, dis-

charge and enforcement.’’

Recently in Lynch v. United States, 292 U. 8. 571, con-

struing a war risk insurance policy, this Court said at

page 577: —

“The terms of these contracts are to be found in

part in the policy and in part in the statutes under

which they are issued and the regulations promul-

gated thereunder’’.

Rn mecnaevan oa = ON a aS A EE ae AS

ee

15

POINT III.

THE STOCK CERTIFICATE OF THE CORPORATION

CONSTITUTES A WRITTEN CONTRACT EXE-

CUTED BY IT UNDER ITS SEAL.

In re Culbertson’s, 54 F. (2d) 753, 757, (C. C. A.

9); Jones v. Mo. Edison Elec. Co., 144 Fed. 765, 770;

Yoakam v. Providence Biltmore Hotel Co., 34 F. (2d) 533,

541; 36 Columbia Law Review, p. 1343.

In 36 Columbia Law Review, page 1343, where the pro-

vision of the law here involved and the regulation is dis-

cussed, it is said that the stock certificate satisfies the

provisions of the law with reference to a written contract

executed by the corporation.’ See also 50 Harvard Law

Review 322, at page 341.

It was recognized in the debates in Congress that a

stock certificate constituted a written contract within the

provisions of the statute involved in this case, as the col-

loquy between: Mr. Vinson, who was in charge of the Bill

in the House and another Member shows.

5. “But even if it be assumed that there can be no contract with

a non-existent entity, an objection which may be met by the theory

of novation, the stock certificate which incorporates the terms of the

charter, may realistically be viewed as a contract between corpora-

tion and shareholder, and therefore within the contemplation of the

unqualified statutory term ‘contract’.” 36 Columbia Law Review 1343. -

6. 80 Congressional Record, part 6, p. 6230, shows the following:

“Mr. Hoilister: ‘I am not discussing the debt situation. Let

us assume this condition comes into effect with respect to a

preferred stock issue * * *. Let us suppose in the preferred

stock issue it is provided that in the event dividends are de-

clared of more than a certain amount then certain voting rights

will come into effect or certain things will have to happen. Has

that been covered in any way?’

Mr.\Vinson of Kentucky: ‘It seems to me that certainly comes

under agraph 14, the contract provision.’

Mr. llister: ‘That is not a contract.’

Mr. Vinson: ‘Certainly it is a contract.’”

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16

POINT IV.

THE WRITTEN PROVISIONS OF THE STATE LAW

EXPRESSLY DEALING WITH THE PAYMENT OF

DIVIDENDS ARE AS MUCH A PART OF THE

STOCK CERTIFICATE AS IF THEY WERE SET

FORTH VERBATIM THEREIN.

The Bureau o/ Internal Revenue has ruled that where

provisions are set forth verbatim in a stock certificate

restricting the payment of dividends they are within the

provisions of the law involved herein and the taxpayers

are entitled to a eredit. J. T. 3152, C. B. 1938-1, p. 155.

It would be a superflucus and meaningless act to repeat

the provisions of a State law in a stock certificate because

they are as fully part of it as if they were repeated. The

provision of the Revenue Act involved here (see page 4)

merely requires the provision of the contract to be written

and to ‘‘expressly deals with the payment of dividends’’.

This the provision of the State law does. The Revenue

Act does not require the provision to be expressed in the

stock certificate but only to “‘expressly deal with the pay-

ment of dividends’’, The word ‘expressly’? modifies the

word ‘‘deals’’ and not the word ‘‘provision’’. The provi-

sion was required to be express to prevent argument that

merely contracting a debt payable during the taxable year

required by implication the use of earnings for its pay-

ment and not for dividends and to avoid provisions for

sinking funds in bond indentures which said nothing about

dividends. Not only is the rule that doubts must be re-

solved in favor of the taxpayer applicable here (Hassett v.

Welch, 303 U. 8. 303, 314), but it is submitted that Con.

gress could have had no such insubstantial and meaning-

less distinction in mind in enacting the Revenue Law, that

corporations which repeated the words of the law re-

17

stricting dividends in the certificate or in their articles

of incorporation should have relief while those who did

not do this meaningless act should not. A law so pro-

viding would be senseless. This Court has said that ‘‘sub-

stance and not form’’ governs in construing revenue laws

and ‘‘taxation is eminently practical’’. The intent, spirit

and purpose of the law must be sought. The intent was

plainly and reasonably to give relief to corporations which

were forbidden to pay dividends. In other words, the law

allowed the corporation an option to distribute earnings

and not be taxed or not to distribute and be taxed. If a

corporation could not take advantage of this option even

if it wanted to, justice dictated relief and not a grossly

unfair and discriminatory penalty. The Court below erred

in declaring the provision was an exemption which should

be construed strictly. It was declared in the Committee

Reports and in Congress to be a relief provision. (Senate

Report 2156, 74th Congress, 2nd Sess., pp. 12, 13, 15.)

The rule of construction is that relief provisions should

be construed liberally to effectuate their purpose. Old

Colony Trust Company v. Commissioner, 301 U. 8. 379,

383; Helvering v. Bliss, 293 U. S. 144, 151; Cochran v.

Commissioner, 78 F., (2d) 176, 179 (C. C. A. 4); In re

Johnston, 33 B. T. A. 551, 553. In Kelly Springfield Tire

Co. v. United States, 81 F. (2d) 533, 535 (C. C. A. 3 ), the

Court quoted with approval the following statement of the

Court of Claims:

‘When a-sprivilege or concession is granted, as in

this statute, it is the duty of the court to give the

largest and broadest construction in favor of the con-

cession, which the language used will allow in order

to afford the relief which the context jadicates was

intended.”’

18

Even if we assume the provision is in the nature of an

exemption, still it should not be strictly construed against

the taxpayer because it was granted for motives of public

policy and te harmonize with State law prohibiting divi-

dends. In such ease its construction should be liberal.

Compare U. 8. v. Merchants National Trust & Savings

Bank, 101 F. (2d) 399, 404 (C. C. A. 9); Roche’s Beach

Inc., v. Commissioner, 96 F. (2d) 776, 779 (C. C. A. 2):

Helvering v. Bliss, 293 U. 8. 144, 151.

POINT V.

PETITIONER’S CHARTER CONTRACT EXPRESSLY

FORBADE IT TO DECLARE A DIVIDEND IN 1936.

The statute of North Dakota declared:

*‘The directors of corporations must not make divi-

dends except from the surplus profits derived from

the business thereof nor must they divide, withdraw,

nor pay to the stockiolders or any of them, any part

of the capital stock.’’

Under the statute no dividends might have been declared

in the case at bar in the year 1936 because after the earn-

ings for that year there was still a deficit. Ulness v. Dun-

nell, 61 N. D. 95; 237 N. W. 208.7

This Court has said that surplus is what remains after

deducting all liabilities, including the capital stock. Hel-

7. In Ulness v. Dunnell, 61 N. D. 95, at pages 99, 100, the Court

said: “It is a well-settled principle that a dividend cannot rightfully

be declared by a corporation except out of the profits earned by it:

6 Fletcher, Cyc. Corp., pp. 6209, et seq.; Fricke v. Angemeier, 53 Ind.

App. 140; 101 N. E. 821. In this state the principle is embodied

in statute.” *** As noted by the Circuit Court of Appeals in its

opinion, the prohibition of the statute itself rests upon the directors.

It is, however, apparent from the foregoing language that the

Supreme Court of North Dakota has construed the North Dakota

statute as binding the corporation, which appears in any event to

be the only conclusion which can logicaily be reached. Directors are

the agents of the corporation. 3 Fletcher Cyclopedia of Corporations

(Permanent Edition) Section 888. Obviously the corporation, their

principal, will be bound itself by such a Statutory limitation upon

their actions in a matter in which they alone can act as such agents,

since it is only through its agents that the corporation can act at all.

19

vering v. Canfield, 291 U. S. 163, 166; Wiilcuts v. Milton

Dairy Co., 275 U. S. 215, 218. See also Edwards v. Doug-

las, 269 U. S. 204, 214.

This is the uniform definition of it under statutes of

the character above-quoted.

POINT VI.

IMPOSITION OF THE SURTAX ON INCOME WHICH

{S$ NOT DISTRIBUTABLE VIOLATES BOTH THE

TAXING STATUTE AND THE FIFTH AMEND-

MENT.

Under Section 14 (b) the surtax is measured only by

the undistributed net income, which by the differentiation

implicit in the use of the word ‘‘undistributed’’ inescap-

ably implies the possibility of distribution. It is impos-

sible to avod the conclusion that the income in question,

to be considered for surtax purposes at all, must he dis-

tributable; otherwise the tax would not be an undistrib

uted profits tax but merely an income tax. To say, there-

fore, that the tax shall he imposed on undistributed

income which could not be distributed is thoroughly incon-

sistent with the theory of the tax itself, an illogical cun-

struction which should not be permitted.

That the 1936 income of the petitioner was not distrib-

utable income is easily demonstrated. The laws of North

Dakota, as above mentioned under Point V, prohibit dis-

tribution of dividends except from surplus profits arising

from the business. In the face of the continuing capital

deficit in 1936, any distribution by. the petitioner to its

stockholders would necessarily have been an encroach.

ment upon capital and consequently a distribution not of

*‘surplus profits’’, but of capital. Such a distribution

would not constitute taxable income in the hands of the

ee

20

stockholders*® and, therefore, the petitioner would ke de-

nied any dividends paid credit for such distribution, skgce

Section 27 (h) of the Revenue Act of 1936 prohibits

dividends paid credit for any part of g distribution which

is not a taxable dividend in the hand§ of stockholders.

Consequently, it is evident that the earnings of this

corperation in 1936 did not constitute net income in its

hands distributable as income and that therefore the tax

imposed by Section 14 cannot, under any reasonable con-

struction of the statute, apply thereto. The decision be-

low, however, would arbitrarily bring this petitioner and

other deficit corporations under this surtax which. by its

terms, should not apply to them. In so doingwit offends

against the Fifth Amendment by unreasonably elassifving

such corporations with others which are differently situ-

ated with respect to the one essential fact upon which the

incidence of the surtax turns.

POINT VII.

THE DECISION BELOW DISCRIMINATES AGAINST

THE PETITIONER IN FAVOR OF OTHERS SIMI-

LARLY SITUATED, IN VIOLATION OF THE FIFTH

AMENDMENT.

It is axiomatic that discrimination in legislation, in-

eluding tax legislation, must be based upon some reason-

able basis of classification if it is not to he condemned

as arbitrary and confiseatory under the Fifth Améndment.

We submit that there exists no reasonable difference

between ‘‘deficit corporations’’, forbidden by charter and

state law to pay dividends, and corporations having con-

tracts restricting dividends, which would justify discrimi-

nation between the two classes with respect to liability

for surtax on undistributed profits.

8. Hadden v. Commissioner, 49 F. (2d) 709 (C. C. A. 2); Hek

vering v. Canfleld, 201 U. S. 163, 166.

— 7 es ; iecichaducies dats ikem tliat emer th ciaa gi aioe

21

It was clearly the intent of Congress in imposing the

tax to penalize, or at least tax, the retention of corporate

income. In the case of corporations which were unable so

to distribute income, Congress attempted to provide legis- NY ett

lative relief under Section 26 (c) of the Revenue Act of

“1936. The beneficiaries of that relief provision were cor-

porations which had contracts preventing the payment of

dividends or contracts which tied up current income for

the purpose of payment of or provision for previous in-

debtedness. The manifest purpose was to avoid the injus-

tice which would result in the case of corporations which,

by reason of definite, preexisting obligations, could not

obtain the dividends paid credit under Section 97. +

From the viewpoint of distribution of income by way _

of dividends, however, which the statute itself makes thé »

controlling factor, there is absolutely no relevant observ-

able difference between corporations subject to restrictive

contracts and corporations which are subject to charter

contract restrictions imposed by state law by reason of

an existing impaigment of their capital. Corporations of

both types, ,in the absence of Section 26 (c), would be

faced with the identical factual problem of being unable ©

legally to distribute income by way of dividends and yet

being taxed for not distributing such income. To say that

one class shall have the benefit of the relief accorded by :

Section 26 (c), and that the other class shall not (although

the only difference is the unsignificant fact that one re-

.Strietion results from an ordinary contract and the other

from a special contract embodied in the corporate charter

and applicable state law), is a violation of the Fifth

Amendment by arbitrary discrimination without any rea-_

sonable factuai basis. It is also a disregard of the intent

and spirit of the Statute.

22

° It is our contention that the charter in the piesent case

constitutes a contract within the plain meaning of Section

26 (c). If, however, such is not the case, then the Revenue

Act of 1936 is fatally defective in so far ‘as the partial

relief of Section 26 (c) results in unjustified and unconsti-

tutional discrimination. Certainly, sufficient doubt is

raised on constitutional grounds to bring the decision of

e Court below within the rule which has many times

been stated by this Court and is thus expressed by Mr.

Justice Holmes in United States v. Jim Fuey Moy, 241

U. S. 394, 401:

“‘A statute must be construed, if fairly possible, so

as to avoid not only the conclusion that it is uncon-

stitutional, but also grave doubts upon that score.

United States ex rel. Attu. Gen. v. Delaware & H. Co.,

_ 213 U.S. 366, 408, 53 L. Ed. 836, 849, 29 Sup. Ct. Rep.

a.

. POINT VIII

THE LEGISLATIVE HISTORY AND INTENT AND

‘SPIRIT OF THE STATUTE SUPPORT PETITIONER.

The Board of Tax Appeals held that because the House

Bill contained a provision which would have given all

deficit corporations relief and it did not appear in the Bill

as amended by the Finance Committee of the Senate, it

necessarily followed Congress did not intend to grant

relief to deficit corporations in states where they could

not legally declare dividends. This does not follow. The

legislative history does not show the reason the provision

was stricken. Non constat it was stricken because the

Senate dic not desire to grant relief to deficit corpora-

tions in those states where they could legally declare divi-

dends and thus were under no contractual obligations

not to do so. It was said in debates in the Senate that

36 states imposed limitations on the declaration of divi-

23

dends by corporations with an impairment of capital

stock. (Con. Rec. Vol. 80, Part 8, ». 9058.) There were

12 states in which deficit corporations might legally de-

clare dividends. Moreover the laws of the 36 states which

prohibited dividends in some form did not all prohibit

dividends where the capital stock was impaired.*

The legislative history supports our contention that

most of the Members of Congress who were lawyers un-

derstood the traditional concept of a corporate charter

as a contract was embraced within the contract provision

upon which we rely. For example, Senator Walsh, a

member of the Finance Committee, made a speech against

the Bill wherein he stated there was no relief afforded

by the Senate Bill to corporations having an impairment

of capital stock. (Con. Rec. 80, Part 8, p. 9058.) After

this speech and after the Senate Bill had been rewritten

in conference in the form in which it was enacted, Sen-

ator Walsh was apparently told that he was wrong and

that his objection was untenable because in the Senate

Minority Report on the Conference Bill, June 19, 1936 (80

Cong. Rec. Part 10, p. 10164) signed by Senators Waish

and George, the following appears:

‘*The defenders of the bil! in the form which it has

now taken contend that by sundry exemptions and

modifications the smallest corporations are spared the

full force of the new .tax as well as helped by the

lowering of the rates on the normal income tax; that

the banks and insurance companies are entirely ex-

cluded; and that in some instances corporations under

9. In a group of states, including California and Delaware, cor-

porations might pay dividends so long as the net assets were not

reduced below the stated value of the preferred stock, albeit such

dividends impaired the common stock, provided they were paid out

of net earnings for the year. An Iowa corporation might pay divi-

dends so long as its assets exceeded its liabilities to others than its

stockholders. (House Hearings, pp. 846, 847.) See 23 California Law

Review, 229. Theory of Anglo American Dividend Law, 28 Col. L.

R. 1046; 29 Col. L. R. 461; 30 Col. L. R. 330, 954.

’

EEN «Sara

on

ii , e

Sa

LAE ets Che

St a RAG

2

coniract not to pay dividends, and forbidden by law

to do so, are permitted without extra penalties to

apply a percentage of their earnings to reserve.’’””

(Italics ours.)

The purpose, intent and underlying spirit of the law

was to prevent rich men avoiding taxes by accumule ting

large earnings in corporations which they controlled. (See

President’s Message in House Report No. 2475, 74th

Cong., 2nd Sess.) See also examination of witness by Sen-

ator Black. Senate Hearings, pages 265 to 268, Sanford

v. Commissioner, 106 F. (2d) 882, 884.

Stockholders of a corporation, the capital of which was

impaired, would not be icvable on distribution made out

of capital. Hadden v. Commissioner, 49 F. (2d) 709 (0.

C. A. 2). Such stockholders upon return of their capital

might even have a loss deductible from other income and

which would serve to reduce their taxes. The purpose of

the law was to force taxable dividends into the hands of

stockholders. A return of capital cannot be made taxable

income by law. Also, as pointed out on page 21 hereof, a

distribution was required to be taxable to a shareholder

before a corporation could take credit for it.

Congress certainly could not have intended to permit

rich and prosperous corporations to avoid this special

surtax and to take that privilege away from deficit cor-

porations and penalize them for being unsuccessful.

10. It should be noted that this was a report on the final Bill which

became law. The preceding bills passing the House and Senate were

Gifferent from this. As said in the supplement to the Law of izcome

Taxation, Paul & Mertens, par. 32A-05: “The House and Senate 1936

Bill. were dissimilar in general aim, theory and in structure. The

1936 Act, as finaliy enacted, was to a considerable extent written in

conference without any new statement of legislative intent—a fact

‘which contributes in no small measure to the difficulty of interpre-

tation of the Act.”

25

To impose a heavier tax on a corporation with impaired

capital stock than on a rich corporation with a surplus

would be to ruin the corporation in failing circumstances

and promote the prosperpus one. Yet, under the construc-

tion of the Court w that is what the law does. This

construction ‘is at yariance with the underlying purpose,

spirit and intent of the Act which the Court below wholly

ignored and is untenable tested from any angle.

For the foregoing reasons the Writ of Certiorari should

be granted.

All of which is respectfully submitted.

JOHN E. HUGHES,

First National Bank Bldg.,

Chicago, Illinois,

Counsel for Petitioner.

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