Plaintiffs Brief — Goodrich v. Edwards
Supreme Court brief1921
Ask Donna
What actually matters in this document.
Text
J | FFB 28 1921
JAMES D. MAH
Cc
Supreme Court of the United States,
OctToBerR TERM, 1920.
No. 663.
Davip M. Goopricn,
Plaintiff in error,
Wituiam H. Epwarps, United States Collector of Internal Revenue for the
Second District of the State of New York.
WRIT OF ERROR TO THE DISTRICT COURT OF THE UNITED STATES FOR THE
SOUTHERN DISTRICT OF NEW YORK.
BRIEF FOR PLAINTIFF IN ERROR.
WILuiAM D. GUTHRIE,
LANGDON P. MARVIN,
Henry M. Warp,
HERBERT POPE,
Rusu C. BUTLER,
Of counsel for plaintiff in error.
ER Ret LIN I
bs a eee eet cag! oy oF Pt PO
fh ee AIPA gee ta yor oe s
AES SEE PES CRIN TB a
INDEX
T. Review of prior statutes and decisions of the eourt
1. The Income Tax Act of 1867. rite
2. The Corporntion Excise Tax Act of 1909...
4. The Inome Tax Act of 1913........
Il. The growth or inerement in value of real or personal property
held for investment when realized by sale is not ‘income *’
within the meaning of the Sixteenth Amendment...
. The meaning of the word ‘‘ineome’’......
B. Gray v. Darlington, 15 Wall. 63.... ae
(. Meaning of the word ‘‘ineome’’ in the law of trusts
D. The British eases . Perr meV Pre
i The definition of income established when the Sixteenth
Amendment was adopted Terrrorer '
F. Realized increase or inerement in the value of an invest
mont is mot **ipoome’’.. wo. oko cece
IN. The Income Tax Law of 1916 does not levy a tax upon the
growth or increment in value of capital assets when realized
_) A, MEET ET oP err errr
capital investments ........... are js ;
B. The changes in phraseology in the Act of 1916 do not in
dicate any intent so to broaden the seope of the ineome
tax as to inelnde realized increment as an item of tax
PE EG Ol de Siri bab £ Wik 6a dee ood eine
mon speeth as exelusive of realized inerement shonld he
deemed to he the meaning of that word in the Act of
RE Sue arse eg ee tall
F. The construction adopted and enforced by the Commis
(7. The contention of the Government hased on practical eon.
IV. As the sale or conversion of the stoek of the Goodrich Company
represented an actual loss, no part of the proceeds was tax
able as income of the taxpayer .. ae ele eidé ca
MUNI 504.55 sutras ta'e'ebe sh oeuan
INDEX TO APPENDIX
Comparison of Income Tax Acts of 1913 and 1916.
Texts of Income Tax Acta of the Civil War period, 1861-1867, so far
21
42!
47
53
ii
TABLE OF CASES CITED
PAGE
Anderson r. Forty-Two Broadway Co., 239 U. s. , Ee 9, 38
Assets Co., Ltd., v. Forbes (1897), 3 Tax Cases, 542; 24 Rettie 578.. 31
Barnes’ Income Tax Practiee in South Africa (1919), pp. 137-140. . 35
7
Bedwell’s Australasian Judicial Dictionary (1920), p. 76........... 35
Bennet v. See Wevtscincctscoverseccecs nn 26
Black on Income Taxes, 4 ed. see. MR Mleturentchevsordekuces... 30, 50
Boardman r. ety WO, G+. .05,.6...
Bohemians Club r. Acting Federal Commissioner of Taxation (1918),
24 Commonwealth Law I OD sceverdtenccesanceresees.., 35
Breadner (Commissioner of Taxation) on The Business Profits War
Tax Act and The Income War Tax Act, GW eitindcodesic. ct... 35
Brewster v. Ne ONO TOE Bevcnrecaviecesccccc 41
Californian Copper Syndicate, Ltd. v. Harris (1904), 5 Tax Cases
caren eV Cac MENUeE Rn arononitradcnivieenesiere’ ccler 31, 32
Carpenter vr. PR TE, Whoo cocvcrexcscaccs.. 27
Chieago, B. & Q. R. R. Co. v. Wy 8 OR OU ce rccccceccs,. 26
Commissioner of Taxes v. Booyesen’s Estate, Ltd., South African
eet SIU Wen seccccesc. 35
Commissioner of Taxes v. Melbourne Trust, Ltd. (1914), A. C. 1001. 31
Cyclopedia of Law and Procedure, vol. 39, p. 444. vol. 40, p. 1788.. 27
Doyle v. Mitchell Brothers Co., 247 U. 8. 179................ 10, 38, 39, 62
Eidman v. cmew eng SS 46, 63
Eisner v. Macomber, 252 U.S. Py sis eta 18, 21, 23, 38, 39, 40, 41, 62
Eldorado Coal and Mining Co. v. Mager, No. 609, October Term,
NCR ein stpnereresaveesseacecuse ce 1, 30, 56
English & American Encyclopedia (2 ed.), Vol. 28, Pe Bit becerece 27
Evans v. Gore, 253 U. 8. Peri sabbuseretivicdsertiessccl 21, 23
Ex parte Bain, 121 U. IP Metwaniccduowsceviniowesdaesentcar 37
Flint rv. Stone Vilciondrtsredsteoadan tmatean 10, 11, 38
Gibbons v. Mahon, 136 U. MMe veneeeidescvevevcecesessJca: 28,41
Gould vr. yo hg A Shae ate dabids 45, 59, 63
Graham’s Estate, 198 Pa. St. 216 27
8, 13, 15, 18, 24, 25, 26, 35, 38, 41, 42, 44, 57, 58
Gulf Oil Co. v. mpg ge haat detain dade 15
Guthrie’s Trustee r. WG OR ie scccicccrsscc 27
Hawaii v. a Dow Se 64
Hays v. Gauley Mountain wat Go, S67. G. tgp...” 10, 38
Holy Trinity Church v. United States, 143 U. s. i vveieeeess 64
Houghton v. Payne, 194 W. §. DU eebbirerseisehidlecinsec.. 59
Hudson’s Bay Co., Ltd. r. Stevens (1909), 5 Tax Cases, 424...... 31, 33
hE se lg i dd a 27
Inland Revenue v. Western Steamship Co. ( 1907), 44 Se. L. R. 715... 36
Interstate Commerce Commission vr, B. & O. R. R. Co., 145 U. s. 263 30
Interstate Commerce Commission rv. Del., L. & W. R. R. Co., 220
BT Pretoria trattowemiecuersercceresorrccn om te 31
Kepner rv. United ee OUR icavsreeckchete cis, 25
Knowlton vr. SE eM Mecrirsesevcecesiec 56, 64
eek oe Oe © Se nerve 13, 14
Lynch v. Turrish, 247 U. §. 221,
PF }
iii
PAGE
MeCoach rv. Minehill & Schuylkill Haven R. R. Co., 228 U. 8. 295.... 11
MeCulloch v. Maryland, 4 Wheat. 316..........................' 23
MeDonald v. Hovey, 110 U. 8 619....................07°7°7°""" 31
McLachlan v. Commissioner of Taxes (1912), South Australian Law
MD UE Sekt hs tirevedenicwncssierasrceasicucseosiercesc.., 35
Maryland Casualty Co. v. United States, 251 U. 8. 342............ 48
Meteet 68 Gowy, 05 BH. Y. 666.........00cceceeesse.... 7
Mente v. Eisner, 266 Fed. 161 (No. 447, Oct. Term, 1920)........ 15, 49
Mercer v. Buchanan, 132 Fed. ou hf... S>eepeaaeenee
Merchants’ Loan and Trust Co. v. Smietanka, No. 608 October Term,
WEE Neko eRuentieeedeWasdseteevivepuccerrecdcencccc. 1, 29, 55, 56
Meeritt ©. Cameron, 187 U. &. 542.....................000°) 58
Mooney v. Commissioners of Taxation (1905), 3 Commonwealth Law
ee Gs GOK, © BOR... ercccsscosereeseceseess.... 35
Hoet"s Metate, 207 Pi, Bt. 466... . 2... cece ccccccceeoceess.. 27
NS ED oir ecnvivecinreeercceccscs 12
Norfolk Southern R. R. Co. r. Chapman, 244 U. 8. 276............. 25
Outeault v. Appleby, 36 N. J. Bt Petwbandeeesbartuesr acco. o. 27
Parker v. Johnson, 37 N. J. Pe MN GUvinatietieocaceetonesesic. 27, 28
Peabody c. Eisner, 247 U. 8. 347.......................000077°"" 13, 14
Pickett v. United States, 216 U.S. 456.............01. 77° 777°°"" 64
Pollock v. Farmers’ Loan & Trust Co., 157 U. 8. 429; 158 U. 8. 601. 11,22
Pontifex’s Canadian Income Tax, EE Mat edi dkindetceedaeni cued. 35
Royal Insurance Co. v. Watson, 3 Tax Dye Fivnscuvecacuc 36
Savings Bank v. United States, 19 Wall. 297 rere re 59
Scoble v. Secretary of State for India (100% » B.C. OOD... cee 31
Shiels v. Commissioner of Taxes (1912), South Australian Law Rep.
nivineddyGon aswel icavieu 35
Mocmm s. Ames, 19 BT 401... 27
im © Meme, 8 MA O8,,..........,.5............. 18, 27
Smith v. Westinghouse Brake Co. (| 44s Pas Cases 357......... 36
South Carolina v. United States, 199U S 497.00 37
Southern Pacifie Co. v. Lowe. 247 US 44 14, 15, 24, 58
Spreckels Sugar Refining Co. v. MeClain, 192 U8 397 Ere fey 12
Stratton’s Independence v. Howbert, 231 U. 8. 399 ves mneis 24, 37, 64
Stott o. Hoddinott, 7 Tax Cases 85.....................0°°°°°™ 36
Studebaker v. Perry, 184 U.S. 258... (eee eine ea Wdwedes 59
Taxation Commissioners v. Mooney (1907), A. C. 342............ 31, 33
Tebrau (Johore) Rubber Syndicate, Ltd. v. Farmer (1910), 5 Tax
SOU EN Ntintdasuswardnicebawdebedéyseeucrcoks cord ct 31, 33
Se Oe UNO Be We Ds raaiac sbvcndckcascacvcis ce 27
Towne v. Eisner, 242 Fed. FR Oe We Oe Behe cane ebeecs io 28, 29
United States rv. Cleveland, &e., Ry. Co., 247 U. 8. 195............ 10, 38
United States v. Delaware & Hudson Co., 213 U. 8. 366........... 63
United States v. Jin Fuey ., .. 1S 9 ” Seeeeeeeteaest 63
United States v. Kirby, 7 Wall. 482................... 077777777"
United States v. Oregon-Washington R. & Nav. Co., 251 Fed. 211.... 24
United States v. Palmer, 3 Wheat. 610..........................7 64
United States v. Standard Brewery, 251 U. 8. 210................. 63
United States v. Steever, 222 U. 8. 167.................00770777" 60
United States v. Tanner, 147 U. 8. 661.....................000°7" 58
United States v. Whitridge, 231 U. 8. 144..........2. 0° 577' 7777 38
Walsh v. Brewster, No. 742, October Sy Geter deeeeddepe news 1, 2, 41
Watney v. Musgrave, 1 Tax DN PU esidetedweccdcued ouces cc. 36
Webb v. Australian Deposit & Mortgage Bank, Ltd. (1910), 11 Com-
NE OP GA) GD. cnc cecsredcnvcsccevesveccenress.. 35
OLE ns He SET oe: . a
SUPREME COURT OF THE UNITED STATES,
Ocroprr Tex, 1920.
No. 663.
Davipv M. Goopgicn,
vs.
Wutiam H. Epwaxps, United States Collector of Internal Revenue for the
Second District of the State of New York.
Plaintiff in error,
WRIT OF ERROR TO THE DISTRICT COURT OF THE UNITED STATES FOR THE
SOUTHERN DISTRICT OF NEW YORK.
BRIEF FOR PLAINTIFF IN ERROR.
This case comes before the court on writ of error to
the District Court of the United States for the Southern
District of New York to review a judgment entered on
December 17, 1920, sustaining a demurrer to the com-
plaint on the ground of insufficiency. The facts pleaded
and all inferences of fact to be drawn from the facts
pleaded are, therefore, admitted. The plaintiff in error
was plaintiff below.
STATEMENT.
The complaint on its face presents the same question
of constitutional law as is presented in Merchants’ Loan
and Trust Company v. Smietanka, No. 608, and Eldorado
Coal and Mining Company v. Mager, No. 609, of the pres-
ent term, now under advisement, and also involved
in Walsh v. Brewster, No. 742 of the present term,
namely, whether the growth or increment in value of
property held for investment and constituting part of
the taxpayer's capital, is, when realized by the sale
a
or conversion of such property, taxable as income un
der the Sixteenth Article of Amendment to the Consti.
tution of the United States. The case also presents the
question of construction of the Income Tax Law of 1916,
as to whether or not a gain realized upon such sale by
an individual investor is ineluded within the terms of
that act as an item of taxable income. The case farther
presents a question of construction, not involved in the
other cases now under advisement, as to whether, when
a loss has in fact been sustained by the taxpayer upon
e the sale of property acquired prior to March Ist, 1913,
he is nevertheless taxable upon the difference between
the price realized upon the sale and the value of the prop.
erty upon March Ist, 1913, the selling price being lower
than the price or value at the time of actual acquisition.
In Walsh v. Brewster similar questions are involved with
respect to investments acquired in 1899, and 1906, and
sold in 1916, some at a profit and others at the same price
at which they were purchased prior to March 1, 1913.
The plaintiff made his return and paid a tax on his
concededly taxable income on May 10, 1917; but the
Commissioner of Internal Revenue assessed an adddi-
tional income tax, and the defendant made demand for
payment of this additional tax on May 6, 1920. The
plaintiff paid under duress and protest on May 15, 1920,
the sum of $3,490.87 on account of the additional tax so
assessed (record, p. 6). On August 6, 1920, the plain-
tiff filed his application for a refund of the additional
tax so paid, which was denied by the Commissioner on
October 26, 1920, and this action was thereupon duly
brought against the Collector (pp. 6, 10).
The proceeds of the sale of two lots of securities are
involved. Of the total of the tax of $3,490.87 so paid un-
4
.
dor said reassessment, the sum of £145.91 wasn bawed
upon alleged income in the form of alleged gain amount
ing to the sum of $120,710.75 claimed by the Comin
sioner to have been derived by the plaintiff from the aale
in 1916 of 3,600 shares of the common stock of the B .
Goodrich Company, a New York corporation (py. 6, 7),
and the remainder (viz. ALG) wax bawed by the Com
missioner upon alleged income in the form of gain
amounting to $13,206.22, derived by the plaintiff from
the sale in 1916 of 1.000 shares of wtock of the United
Verde Extension Mining Company bought in 1912 ax an
investment (pp. 6, 9).
It was conceded below in and by the demurrer that
the plaintiff was not at any of the tines alleged in the
complaint “in any sense engaged in the bu«iness of Imy
ing or selling stocks, bonds, or other mewmrition’’ (py. Ty:
that the shares of capital stock of the Goodrich Conmpany
were reecived by him in May, 192, upon a reoryanina
tion, in exchange for stork acquare”d by him in or prior to
1907 partly through gift ane partly through inheritances
from his mother, aud that the shares of the Mining Com
pany were aquired in 1912 through aUbeeription aud pus
chase for investment (pp. 7, 9). The queetions pre
sented, therefore, arise solely in connertion with property
held as investment and in no wenn, as the demurrer
admits (p. 5), in connection with the transaction of a
trade or business.
The facts with respect toe the stork of the Goodrich
Company are as follows (pp. 7-9):
The plaintiff's father, B. F. Goodrich, died in Au.
gust, 1855, owning several thousand shares of stock of
the B. F. Goodrich Company, a corporation of the State
of Ohio. By his will he bequeathed thie stock to hin
‘4
widow, the plaintiff's mother. During her lifetime she
gave the plaintiff « part of the shares of said stock, and
on her death in 1907 bequeathed to him by her will other
shares of said stock. The plaintiff continued to hold the
same until May, 1912, when the Ohio Company was re-
organized, and the business and assets transferred to a
new corporation organized under the laws of the State of
New York with the same name. The plaintiff thereupon
exchanged his shares of stock in the Ohio corporation for
shares of stock in the New York corporation and cash.
(0 the date of such exchange, shares of this stock in the
New York corporation were of the fair market value of
#1 per share. The plaintiff sold 3,000 shares of said stock
of the New York Goodrich Company, se reecived by him
in May, 1912, on various dates in 1916 between February
and July, at a total price of $269,346.25, the average price
received on said sales being $74.82 per share, and the
prices being in cach instance less than $8] per share.
The total value of the said 3,600 shares in May, 1912, was
$291,600, and the plaintiff upon the sale thereof received
$22,253.75 less than such value. On March 1, 1913, certain
shares of said stock were sold on the New York Stock
Exchange at an average price of about $41.25 per share.
The Commissioner of Internal Revenue on this basis com-
puted and determined the total fair market value on
March 1, 1913, of the 3,600 shares so sold to be $145,625.50,
and held that, with respect to the sale of said 3,600 shares
of stock, the plaintiff in the year 1916 received a taxable
gain equal to the difference between the market value of
said stock on March 1, 1913, viz., $148,635.50, and the total
sale price in 1916, viz, $269,346.25, and was, therefore,
taxable on the sum of $120,710.75 as “net income.”
With reepect, consequently, to the shares of steck of
the Goodrich Company, there was no growth or increment
or accretion or gain whatever in value from the time of
acquisition by the plaintiff wutil the time of sale, but, on
the contrary, a depreciation or shrinkage in value, liqui-
dated upon the sale in the sum of $22,253.75, which in
fact comstituted a lows to the plaintiff.
The facts with respect to the sale of the shares of
stock of the United Verde Extension Mining Company
are as follows (p. 9);
During the year 1912 the plaintiff subscribed for and
bought for investment 1,000 shares of the capital stock
of said miuing company at fifty cents per share, making
a total purchase price of $500, and on March 7, 1916, sold
them for the sum of $12,991.22. On March 1, 1912, the
stock of said mining company was quoted on the New
York Stock Exchange at an average price of 69'. cents
per share, and the Commissioner found this price to be
the fair market value of said stock as of Mareh 1, 1913,
aml the total market value on said date of said 1,000
shares to be $695. The Commissioner thereupon as-
seseed an income tax against the difference between said
valuation on March 1, 1912, and the «ale prece realized,
amounting te $13,296.22, such sum representing the
growth or increment in value of said investment from
March 1, 1913, to the date of sale, March 7, 1916, and
with respect to the same the plaintiff paid a tax of
£44.96 (p. 6).
The controlling and conceded facts in the case at
bar are, therefore, (1) that the plaintifl acquired and at
all times held the securities in question as investments,
and not in connection with the transaction of any trade
or business carried on for gain or profit, (2) that on the
a
fioodrich Company's stock there was no gain whatever
but an actual loss or dimunition of capital growing out of
the ownership or use of or interest in such property,
amd (3) that the gain or profit realized on the Min
ing Company's stock was the result of the growth, in.
erement, or inerense in value of a capital asset owned
and held for investment sinee 1912.
Jn an appendix to this brief the relevant and perti
nent provisions of the Income Tax Laws of 1913 (48
Stat, 166) and 1916 (39 Stat. 756), are printed in parallel
columns with appropriate variations of type to denote
the difference in phraseology.
ASHIGNMENT OF BRRORS.
1. That the court below erred in sustaining the de
murrer of the defendant.
2. That the court below erred in ruling that the said
Act of Congress of September 4, 1916, as construed hy it,
was constitutional and within the taxing power delegated
to Congress in and by the Sixteenth Article of Amend
ment to the Constitution of the United States.
3. That the court below erred in ruling that any
part of the proeceds of the sale of the shares of the cap-
ital stock of the Goodrich Company constituted net income
taxable under said Act of Congress.
4. That the court below erred in ruling that any
part of the proceeds of the sale of the shares of the cap-
ital stock of the United Verde Mining Company consti-
tuted net income taxable under said Act of Congress.
-
nt
Cea Trees,
—_
I.
Revirw OF PRIOR STATUTES AND DEC ISIONS OF THE COURT,
Before discussing the question of the true meaning
and scope of the term “incomes, from whatever source
derived”? contained in the Sixteenth Article of Amend-
ment to the Constitution of the United States and its
equivalent in the Act of 1916, it may be useful to review
the prior statutes and decisions of this court in cases
which involved questions of increase in value of capital
investments. These cases arose respectively under three
faxing laws of Congress, viz., (1) the Income Tax Act
of 1867 (14 Stat. 471, 478, ©. 169), (2) the Corporation
Excise Tax Act of 1900 (26 Stat. 11, ¢. 6), and (3) the
Income Tax Act of 1913 (38 Stat. 166, ©. 16).
(1) The Income Tax Act of 1867 provided as fol-
lows (p. 478):
“That there shall be levied, collected, and paid
annually upon the gains, profits, and income of
every person residing in the United States, or of
any citizen of the United States residing abroad,
whether derived from any kind of property, rents,
interest, dividends, or salaries, or from any pro
fession, trade, employment, or vocation, carried
on in the United States, or elsewhere, or from any
other source whatever, a tax of five per centum on
the amount so derived over one thousand dollars,
and a like tax shall be levied, collected, and paid
annually upon the gains, profits, and income of
every business, trade, or profession carried on
in the United States by persons residing without
the United States, and not citizens thereof. And
the tax herein provided for shall he assessed, col-
lected, and paid upon the gains, profits, and in
come for the year ending the thirty-first day of
December next preceding the time for levying, col
lecting, and paying said tax.
8
‘‘In estimating the gains, profits, and income
of any person, there shall be included all income
derived from interest upon notes, bonds, and
other securities of the United States; profits real-
ized within the year from sales of real estate pur-
chased within the year, or within two years pre-
vious to the year for which income is estimated;
. . all other gains, profits, and income de-
rived from any source whatever.’’
This court held in Gray vy. Darlington, 15 Wall. 63,
that the provisions above quoted did not include or tax
an advance in the value of property during a series of
years, although the entire amount of the advance had
been realized in the taxable year by a sale of the prop-
erty and conversion of the investment into money. Mr.
.
.
5 Justice Field, delivering the opinion of the court, among
4 other things, said (at p. 66) :
. . °
‘ ‘*The mere fact that property has advanced in
ri value between the date of its aequisition and sale
a does not authorize the imposition of the tax on
i the amount of the advance. Mere advance in value
in no sense constitutes the gains, profits, or income
: specified by the statute. It constitutes and can be
p treated merely as increase of capital.’’
4 In so deciding the court reached the same conclusion
4 by substantially similar reasoning as was reached by the
; courts in Mngland in construing the Income Tax Law of
3 that country and it likewise recognized, as the English
3 courts have done, the distinction between a trader and
= ; ss
4 merchant on the one hand realizing a gain or profit in
« his business and an investor on the other hand realizing
a gain or profit on an isolated transaction unconnected
with his trade or business, which distinetion is fully dis-
: cussed in the cases cited below under point II.
, In Lynch v. Turrish, 247 U.S. 221, the court followed
> Gray v. Darlington, and quoting from that case among
other things said (at p. 230) :
=
9
‘‘This case has not been since questioned or
modified.
‘The Government feels the impediment of the
case and attempts to confine its ruling to the exact
letter of the Act of March 2, 1867, and thereby dis-
tinguish that act from the Act of 1913 and give
to the latter something of retrospective effect. Op-
posed to this there is a presumption, resistless
except against an intention imperatively clear.
The Government, however, makes its view depend
upon disputable differences between certain words
of the two acts. It urges that the Act of 1913
makes the income taxed one ‘arising or accruing’
in the preceding calendar year, while the Act of
1867 makes the income one ‘derived’. Granting
that there is a shade of difference between the
words, it cannot be granted that Congress made
that shade a criterion of intention and committed
the construction of its legislation to the disputes
of purists. Besides, the contention of the Gov-
ernment does not reach the principle of Gray v.
Darlington, which is that the gradual advance in
the value of property during a series of years in
no just sense can be ascribed to a particular year,
not therefore as ‘arising or accruing’, to meet the
challenge of the words, in the last one of the years,
as the Government contends, and taxable as income
for that year or when turned into cash. Indeed,
the case decides that such advance in yalue is not
income at all, but merely increase of capital and
not subject to a tax as income.”
(2) It is not necessary to quote the language of the
Corporation Excise Tax Law of 1909. As has been re-
peatedly pointed out by the court, that act “was not in
any proper sense an ineome tax law, nor intended as
such, but was an excise upon the conduct of business ina
corporate capacity, the tax being measured by reference
to the income in a manner prescribed by the act itself”’
(Anderson v. Forty-Two Broadway Co., 239 U. 8. 69, 72,
citing previous cases.) Hence, it follows that the deci.
sions under the Act of 1909 are not in point as to the
REL CPI TOOK COURT MELE TIE MOE HE HLT REL AE
10
true meaning of the term ‘‘income’’ in an income tax
statute or constitutional provision. The excise upon the
conduct of business in a corporate capacity could prop-
erly be measured by either capital or income, gross or
net, and include in such measure or standard, items not
in their essence income at all. Flint v. Stone Tracy Co.,
220 U. S. 107. This fully distinguishes the cases arising
under the Act of 1909, such e.g. as Doyle v. Mitchell
Brothers Co., 247 U. S. 179; Hays v. Gauley Mountain
Coal Co., 247 U. S. 189, and United States v. Cleveland
éc. Ry. Co., 247 U. S. 195. Moreover, the Act of 1909
was construed by this court in these cases as taxing cor-
porations not upon all income received during the tax-
able year but ‘‘by a measure based upon the gainful re-
turns from their business operations and property
from the time the act took effect’? and “conveying
rather the idea of gain or increase arising from corporate
activities’’ (Doyle v. Mitchell Brothers Co., at pp. 183
and 185), and therefore as excluding income that accrued
before that date (Hays v. Gauley Mountain Coal Co., at
p. 192). In thus construing the Act of 1909 as excluding
gains or profits or income accruing prior to January 1,
1909, the court was not defining the term ‘‘income’? in any
sense beyond that applicable to the construction of the
act then under consideration, nor was it intimating that
increase in value of capital assets accruing prior to Janu-
ary 1, 1909, would not be income whilst a similar increase
in value accruing after that date would be income. The
Act of 1909 would have levied a constitutional excise tax
if it had been measured by the entire receipts or the gross
income of corporations without regard to when gains or
profits had accrued, for what was taxed was not gains or
profits or income as such but ‘‘the particular privilege of
——
11
doing business in a corporate capacity’’ (Flint vy. Stone
Tracy Co., 220 U. 8. 107, 151). Therefore, the fact that
Congress saw fit to adopt a measure for the excise tax it
then levied, which included only gains accruing after a
fixed date and excluded those accruing before that date,
has little or no logical bearing or relevancy upon the
question as to what does or does not constitute “‘income”’
within the meaning of the Sixteenth Amendment or with-
in the intent of Congress in levying a direct tax without
apportionment upon ‘‘incomes, from whatever source de-
rived.’’ The Corporation Tax of 1909 was expressly
sustained only upon the ground that it was not in any
respect a direct tax; or stated in other words, it was
sustained only because it was an excise and not an in-
come tax within the meaning of the latter term as com-
monly and currently understood and as passed upon in
Pollock v. Farmers Loan & Trust Co., 157 U.S. 429; 158
U.S. 601. Of course, the selling of property by a corpo-
ration whether at a profit or a loss was the doing of busi-
ness in a corporate capacity, and it was immaterial that
the property sold was held by the corporation as a sepa-
rate investment.
The point that the word ‘‘income’’ in the Act of 1909
meant gain or increase arising solely from corporate ac-
tivities is further elucidated by the opinion of the court in
McCoach v. Minehill & Schuylkill Haven R. R. Co., 228 U.
8. 295, 305-306, where it was held that the tax was not
imposed upon a corporation not engaged in active busi-
ness, though in the receipt of a large net income,
The recent Income Tax Laws have specifically dealt
with net income, and in no case have they sought to tax
the gross receipts or gross income of the taxpayer. Thus,
in one clause of section 1 of the Act of 1916 the phrase
— a i oe ee
12
is ‘‘entire net income”’ (a), whilst in the following clause
it reads ‘‘total net income’’ (b), but both refer to such
part of the proceeds of sales, or dealings in real or per-
sonal property as does not represent capital but is in-
dependently ‘‘derived from capital, from labor, or from
both combined.’’ A tax on gross income from all sales
wonld not be valid as an income tax,* although a tax would
be valid if levied as an excise tax on the carrying on of a
business or trade or profession, measured by gross in-
come. Spreckels Sugar Refining Co. v. McClain, 192 U. 8.
397, 413.
(3) The Income Tax Act of 1913, the first Income Tax
Law under the Sixteenth Amendment, provided in par. A,
subdiv. 1 (38 Stat. 166, c. 16) as follows (see appen-
dix) :
‘That there shall be levied, assessed, collected
and paid annually upon the entire net income aris-
ing or accruing from all sources in the preceding
calendar year.’’ . . . ete.
It will be noted that in the Act of 1913 as well as in
the Sixteenth Amendment, substantially the same formu-
la was adopted as was contained in the Act of 1867. The
phrase ‘‘all income derived from any souree whatever”
in the Act of 1867 became ‘‘incomes, from whatever source
derived”’ in the Amendment, and the phrases levying the
tax in the Acts of 1867 and 1913 are substantially and in
effect the same, and especially so in the feature that the
tax was to be levied ‘‘ annually upon the entire net income
arising or accruing from all sources in the preceding
calendar year.’’ The substitution of the words ‘‘arising
or accruing’’ for the term ‘‘derived’’ involved but a neg-
ligible ‘‘shade of difference,’’ as was pointed out in
Lynch v. Turrish, supra.
As we have seen, the Act of 1913 came before the court
* In Nicol v. Ames, 173 U. 8. 509, 521, the court recognized that a tax
on all sales would be ‘‘really and practically upon property.’’
"4
LILI LE LLL LON LEBEN PF ee HI ies 19
13
for construction in Lynch v. Turrish, 247 U. 8. 221, ina
case involving an advance in value of corporate assets and
the distribution of the proceeds among the stockholders.
It was then held that the rule in Gray v. Darlington ap-
plied and was controlling, clearly upon the ground that
the provisions of the Act of 1913 were substantially the
same as those of the Act of 1867, and that a mere advance
in value realized on the conversion into money of an exist-
ing capital investment did not constitute income within
the meaning of either act. It is true that the gain or profit
in that case actually accrued before the Act of 1913 be-
came effective, but that feature was emphasized only as
bearing upon the intent of Congress and the construc-
tion of the statute. There is nothing in the reasoning of
the opinion to indicate that, in the opinion of the court,
if the advance had taken place or accrued after March
Ist, 1913, the nature of the item would have been thereby
changed from capital into net income and a different
rule of law have been applicable. If in its nature essen-
tially capital before the Act of Congress or the adoption
of the Amendment, it certainly must continue to be
capital thereafter. This should follow quite clearly and
indisputably when it is recalled that in the eases of
Lynch v. Hornby and Peabody v. Eisner, 247 U. 8. 339
and 347, both argued at the same time as Lynch vy.
Turrish, and decided on the same day, it was held that
it was immaterial and irrelevant that a surplus out of
which corporate dividends were paid or payable had
accumulated prior to the Act of 1913, because dividends
from investments in stock ‘are commonly reckoned as
dividends, and are expended as such by the stockholders
without regard to whether they are declared from the
most recent earnings, or from a surplus accumulated from
the earnings of the past, or are based upon the increased
value of the property of the corporation”’ (p. 344). The
a
—$<—.
basic and controlling difference between the two classes
of cases was that in those like Lywch v. Turrish the trans-
action was not the declaration and payment of a dividend
in the common understanding of that term or in the or-
dinary course of the business of a corporation, but was
a conversion or transmutation of capital Assets into
money for final distribution among stockholders as capi-
tal, whilst in cases like Lynch v. Hornby and Peabody vy.
Kisner, the transactions constituted the declaration and
payment of dividends in the ordinary, current and com.
mon acceptation of that term, and it was quite immaterial
when the net earnings out of which the dividends were
paid or payable had accrued to the corporation.
The case of Southern Pacific Co. vy. Lowe, 247 U.S.
330, also arose under the Aet of 1913. The facts were pe-
culiar, but the fundamental inquiry was as to the nature
of accumulations and increase in value of corporate
assets prior to January Ist, 1913. The Government con-
tended that as a dividend of the amount of these accumn-
lations had actually been declared and practically paid
in 1914, it constituted part of the corporation's gross
‘‘income”’’ in the sense of something coming in, realized,
received, arising, or accruing during the taxable term, and
could not, therefore, be treated as capital assets instead
of income. Answering this contention, the court said (at
p. 335):
14
‘‘We must reject in this case, as we have re-
jected in cases arising under the Corporation Eyx-
cise Tax Act of 1909 (Doyle v. Mitchell Brothers
Co., ante, 179, and Hays v. Gauley Mountain Coal
Co., ante, 189) the broad contention submit-
ted in behalf of the Government that all receipts
—everything that comes in—are income within the
proper definition of the term ‘gross income’, and
that the entire proceeds of a conversion of capital
assets, in whatever form and under whatever cir-
—
15
cumstances accomplished, should be treated as
income. Certainly the term ‘income’ has no
r meaning in the 1913 Act than in that of
1909 (see Stratton’s Independence vy. Howbert,
231 U. 8. 399, 416, 417), and for the present pur-
we assume there is no difference in its mean-
ing as used in the two acts. This being so, we are
bound to consider accumulations that accrued to
a corporation prior to January 1, 1913, as being
capital, not income, for the purposes of the act.
And we perceive no adequate ground for a dis.
tinction, in this regard, between an accumulation
of surplus earnings, and the increment due to an
appreciation in value of the assets of the tax-
ane (See also Gulf Oil Co. v. Lewellyn, 248
. 8.71.)
There can be no doubt that if increase or increment in
value of a capital investment became income whenever
realized by conversion into money or other property, or
in other words, if what was essentially a part of capital
was changed in its nature and substance by the mere act
of conversion or realization, the conclusions reached in
the cases of Gray v. Darlington, Lynch v. Turrish and
Southern Pacific Co. v. Lowe, were erroneous.
As discussed below, an examination of the Acts of
1913 and 1916 will show that Congress had clearly in
mind that gains and profits or losses resulting or aceru-
ing from the trade or business of a taxpayer were to be
regarded and treated as distinct and separate from gains
and profits or losses resulting or accruing from isolated
transactions* or capital investments not connected with
the carrying on of any trade or business. The Act of
* The phrase ** isolated transactions,’’ to characterize transactions sep
arate and apart from a aw regular trade or business, seems to have
Treasu under the Act of 1913
16
1916, moreover, for the first time introduced among the
provisions as to allowable deductions, the following :
‘Fifth. In transactions entered into for profit
but not connected with his business or trade, the
losses actually sustained therein ing the year
to an amount not exceeding the arising
therefrom.”’
Clearly, if Congress had not then had in mind the
subject of gains and profits or losses resulting from
transactions independent of business or trade, no such
provision would have been inserted. It will further be
noted that reference was made not to all transactions of
the taxpayer not connected with his business or trade,
but only to those ‘“‘entered into for profit,’’ language
which plainly differentiated investments acquired for in-
come from more or less speculative ‘‘transactions en-
tered into for profit.’’
Under the Act of 1916, therefore, every taxpayer had
to cover in his income tax return and the Government
was called upon to investigate and differentiate the fol.
lowing among other items:
(1) The entire net income received or derived from
any source whatever.
(2) Net income received from ‘‘the transaction of
any business carried on for gain or profit.”’
(3) Losses actually sustained during the year, ‘‘in-
curred in his business or trade.’’
(4) Losses actually sustained during the year ‘in
transactions entered into for profit but not connected
with his business or trade. . . . to an amount not ex-
ceeding the profits arising’’ from similar transactions.
Capital losses, however, were not generally allowed
to be deducted, because, it is proper and reasonable to
infer, under neither the Act of 1916, nor the Act of 1913
—-_- rr
—
17
upon which it was based, was it intended to tax the pro-
eceds of capital assets sold at an increase over their cost
any more than such proceeds were taxed under the Act of
1867.
The Government concedes that, of course, nothing is
now income which was not income before the adoption of
the Sixteenth Amendment and that mere increase in
value, while it remains such, is not income but still capital.
It urges, however, that an amount equal to any increase
in value of property held for investment becomes income
as soon as and whenever the investment is converted into
cash or into other property. In other words, the conten-
tion is that although the entire investment is clearly capi-
tal while unconverted, a part becomes income upon con-
version to the extent of any realized gain or profit.
The fundamental difference between the Government
and the plaintiff is principally one of definition. If the
term “‘inecomes’’ in the Sixteenth Amendment and the
statutes now in question means ‘‘all receipts—everything
that comes in,”’ then clearly even the proceeds of invest-
ments sold at a loss would be receipts and would be money
coming in. This view having been rejected as unsound,
a narrower sense or meaning of the term ‘‘income’’ must
necessarily be accepted. The Government, therefore, sug-
gests a meaning which it alleges obtains in current speech
and common understanding, and contends that such mean.
ing includes the realization by sale or conversion of
increase in value of property held for investment.
There are three definitions by the court itself, as a
result of the process of inclusion and exclusion, to which
reference should be made, viz. :
(1.) **Mere advance in value in no sense con-
stitutes the gains, profits, or income i
the statute. It constitutes and can treated
ah i) ae
: |
5:
=i
i
| He
zn a aaa Hal! Ht
the shares and if it be part of the shares them-
selves then, whilst it may be profit, it is in no sense
income.”’
It is true that there are various other dictionary mean-
ings of the term ‘‘income'’, some broad and some narrow
and some usual and others rare or obsolete; but the cur-
rent meaning in common speech ix what the court has ree.
ognized and stated in the above quotations. A man not
engaged in the business of buying and selling, say, real
estate, who hax held such property, it may be his home,
for a series of many years, and who then sells it at an
inerease over what he paid, would not reasonably or sen-
sibly regard or treat the gain thus made as income. He
would net ordinarily inelude any part of the proceeds of
such an isolated transaction, perhaps the only one of its
kind in many years or a life time, as part of his annual
imeome. (im the contrary, if commonly prudent and con-
servative, he would regard and treat it as still an integral
part of his permanent capital, to be used, if necessary, to
offset or meet past or future capital losses, or to replace
what he had sold with property equal in value or pro-
ducing equal income.
Again: a man not engaged in the business of dealing
in bonds and stocks, who had purchased securities for in-
vestment and not for speculation, who looked for safety
of investment and certainty of return and not for profit on
a sale or conversion thereof, would not reasonably or
sensibly regard or treat an inerease in value of a par-
ticular security when realized by le or conversion, as
part of his annual income. On t! rary, if ordinarily
cautious and conservative, he w. card and treat it as
still an integral part of his capital, to be used, if neces-
sary, to offset and meet past or future depreciation and
omg
capital losses in respect of other securities, or to replace
what he had sold with other income producing securities.
Or, to take the case of an inheritance: a man inheriting
a homestead or securities (as the plaintiff inherited the
Goodrich stock in the case at bar) and years afterwards
selling the same, could not reasonably regard or treat
any part of the proceeds as income accruing during the
year of the sale. It would all be still part of the capital
he had inherited, and no part of it would be income within
any reasonable meaning or acceptation of the term.
Stated in other words, the current meaning of the
word ‘‘income’’ in common speech and according to com-
mon understanding is the return or gain which is period-
ically or annually derived from capital or from labor or
from both combined, and not the extraordinary gain or
profit which may be derived from an isolated sale of
property held through a series of years for investment
and in no sense connected with the taxpayer’s business
or bought by him for speculation or profit. Such an in-
crease in value of an investment unrealized is always and
properly regarded by private investors as essentially
part of capital, and they do not regard or treat it as.
changed into income merely because it has been converted
into money, it may be for the sole purpose of substituting
another income-producing investment.
The authorities discussed below, it is submitted, es-
tablish the correctness of this conception of the current
meaning and understanding of the term ‘‘income’’ as
used in the Sixteenth Amendment and the Act of 1916.
20
—
Il.
THE GROWTH OR INCREMENT IN VALUE OF REAL OR PER-
SONAL PROPERTY HELD FOR INVESTMENT, WHEN REALIZED BY
SALE, IS NOT “‘INCOME”’ WITHIN THE MEANING OF THE SIX-
TEENTH AMENDMENT,
The Sixteenth Article of Amendment to the Constitu-
tion of the United States, which was declared to be duly
ratified on February 25, 1913 (37 Stat. 1785), provides as
follows:
‘‘The Congress shall have power to lay and col-
lect taxes on incomes, from whatever source de-
rived, without apportionment among the several
States, and without regard to any census or enum-
eration.’’
The Sixteenth Amendment added nothing to the sub-
ject matters theretofore taxable by the Congress, but
merely dispensed with the requirement of apportionment
as to one class of direct taxes, namely, taxes on incomes
derived from the ownership of property. It clearly limits
the taxing power of Congress thereunder to ‘‘incomes”’,
and it does not authorize or permit an unapportioned tax
levy upon capital in any form whatever or under any de-
vice. A tax levy that takes part of the principal or
capital of a property asset of the taxpayer is necessarily
a tax on property as distinguished from a tax on income
derived from property, and is consequently a direct tax,
which must constitutionally be apportioned. The reason-
ing which supports this conclusion is comprehensively and
accurately stated by Mr. Justice Van Devanter in Evans
v. Gore, 253 U. 8. 245, 261-3, and by Mr. Justice Pitney in
Eisner v. Macomber, 252 U. S. 189, 206. In the latter
case, the learned Justice reviewed the effect and scope
of the Sixteenth Amendment in the following language :
22
‘*As repeatedly held, this did not extend the
taxing power to new subjects, but merely removed
the necessity which otherwise might exist for an
apportionment among the States of taxes laid on
income, Brushaber vy. Union Pacific R. R. Co.,
240 U.S. 1, 17-19; Stanton v. Baltic Mining Co.,
240 U. S. 103, 112, et seq.; Peck & Co. v. Lowe,
247 U.S, 165, 172-173.
‘*‘A proper regard for'its genesis, as well as
its very clear language, requires also that this
Amendment shall not be extended by loose con-
struction, so as to repeal or modify, except as
applied to income, those provisions of the Con-
stitution that require an apportionment according
to population for direct taxes upon property, real
and personal, This limitation still has an appro-
priate and important function, and is not to be
overriden by Congress or disregarded by the
courts.
‘‘In order, therefore, that the clauses cited
from Article | of the Constitution may have proper
force and effect, save only as modified by the
Amendment, and that the latter may also have
proper effect, it becomes essential to distinguish
between what is and what is not ‘income’, as the
term is there used; and to apply the distinction,
as cases arise, according to truth and substance,
without regard to form. Congress cannot by any
definition it may adopt conclude the matter, since
it cannot by legislation alter the Constitution,
from which alone it derives its power to legislate,
and within whose limitations alone that power can
be lawfully exercised.”’
The requirement of apportionment imposed in and
by sections 2 and 9 of Article I of the Constitution, there-
fore, remains in undiminished force and effect in respect
of everything theretofore embraced within it, except only
’ Direct taxes on capital and
as to ‘‘taxes on incomes.’
the proceeds of capital still may not be constitutionally
laid without apportionment. Pollock vy. Farmers’ Loan &
Trust Co,, 158 U. 8S. 601, 637. The extent to which the
Constitution remains operative in this relation, and the
Tay ene” een RE SE RE PERE | OI roe
—
23
extent to which the Amendment must be accorded super-
vening effect, are both to be determined only as it is made
apparent what is ‘‘income’’ and what is not ‘*income’’,
within the meaning of that term as employed in the Six-
teenth Amendment and in the light of the fact that other
constitutional provisions equally obligatory (Evans y.
(ore, supra) require that every tax on property, as dis-
tinguished from income derived from property, must be
apportioned,
A.
As stated by this court in Kisner vy. Macomber, it is,
in construing the Sixteenth Amendment, ‘‘ essential to dis-
tinguish between what is and what is not ‘income’ , as the
term is there used, and to apply the distinction, as cases
arise, according to truth and substance, without regard to
form’. Constitutional provisions relating to the ordi-
nary affairs of life necessarily must speak the current
arene as then commonly understood; otherwise they
“would probably never be understood by the publie’’
(McCulloch v. Maryland, 4 Wheat. 316, 407); and where,
as in the Sixteenth Amendment, the provision plainly con-
cerns the every day activities of men, it must be manifest
that its purport and effect were intended to be re: adily
solvable by the ordinary understanding of those to whom
it was addressed. There is nothing to indieate that the
members of the Congress that proposed the Amendment
to the States or the state legislatures that ratified it
understood the term ‘‘incomes’’ in any other than its
commonly understood and judicially defined mean-
ing. Indeed, while with respect to stock dividends,
as is pointed out in the dissenting opinions of Mr.
Justice Holmes and of Mr. Justice Brandeis i in Kisner v.
24
Macomber (252 U.S. 220, 234, Mr. Justice Day concur-
ring in the former and Mr. Justice Clarke in the latter),
the law was by no means well settled in all the States that
such dividends were capital and not income, with respect
to increment of value realized upon the sale of property
held for investment there was complete unanimity in
holding that it was essentially capital and not income.
These considerations enable us immediately to lay to
one side the suggestion, heretofore made by some judges
and earnestly urged by the Government, that the term
‘income’? embraces ‘‘everything that comes in’’ (see, e.
g., United States v. Oregon-Washington R. & Nav. Co.
251 Fed. 211, 212-3, 214; Southern Pacific Co. v. Lowe,
247 U.S. 330, 335), and the further suggestion that in the
science of political economy or theoretical accounting the
word has a peculiar, artificial, or technical meaning.
Stratton’s Independence v. Howbert, 231 U. S. 399, 414;
Lynch v. Turrish, 247 U.S. 221, 227, 228. The former sug-
gestion rests upon the bare etymological derivation
of the word—an element which controls and influences
common usage very slightly; and the latter yields to
distinctions and doctrines of economists all but unknown
to the ordinary individual, and which this court has de-
’
elared are ‘‘such refinements [as] can hardly be deemed
to have entered into the legislative purpose’’ (Stratton’s
Independence v. Howbert, supra). Manifestly, no sub-
stantial aid is to be derived from such lines of inquiry.
Prior to the adoption of the Amendment the meaning
of the word income had been judicially defined by this
court in Gray v. Darlington, by the highest courts of many
of the States in the law of estates and trusts, and by
the courts of Great Britain and of the British Dominions
and Colonies in construing their Income Tax laws, as
5 Ae ak Bk aaa Rae aed IEW FLOR NLS IONIAN STE Y le rm
25
excluding increment of value realized upon the sale of
property held for investment. Probably no source is
more enlightening than the decisions of the courts con-
struing the term in question, for ‘it is a well-settled rule
of construction that language used in a statute [or con-
stitution] which has a settled and well-known meaning,
sanctioned by judicial decision, is presumed to be used
in that sense by the legislative body.”’ Kepner v. United
States, 195 U.S. 100, 124; Norfolk Southern R.R. Co. v.
Chapman, 244 U.S. 276, 280-1.
B.
In Gray v. Darlington, 15 Wall. 63, decided in 1872,
the question arose under the Income Tax Law of 1867,
which levied a tax ‘‘upon the gains, profits, and income
of every person . . . whether derived from any kind of
property ... or from any other source whatever.’’ It
appeared there that the plaintiff had in 1865 acquired
some United States bonds in exchange for United States
Treasury notes as an investment, and not in the course
of any business, and that he had disposed of them in
1869 at an advance of $20,000 over the original cost of
the notes. The Government attempted to tax this sum
under the Income Tax Law of 1867 as ‘‘gains, profits and
income’’; but this court overruled its contention, and
Mr. Justice Field speaking for the court used the follow-
ing language (pp. 65, 66) :
‘“‘The question presented is whether the ad-
vance in the value of the bonds, during this period
of four years, over their cost, realized by their sale,
was subject to taxation as gains, profits, or income
of the plaintiff for the year in which the bonds were
sold. The answer which should be given to this
question does not, in our judgment, admit of any
doubt. The advance in the value of property dur-
ing a series of years can, in no just sense, be con-
26
sidered the gains, profits, or income of any one par-
ticular year of the series, although the entire
amount of the advance be at one time turned into
money by a sale of the property. . . .
‘The mere fact that property has advanced in
value between the date of its acquisition and sale
does not authorize the imposition of the tax on the
amount of the advance. Mere advance in value in
no sense constitutes the gains, profits, or income
specified by the statute. It constitutes and can be
treated merely as increase of capital,’’
It will be noted that the court was then speaking of
an advance in value which had been actually realized by
sale within the taxable year. To the same effect as Gray
v. Darlington, was the opinion of Mr. Justice Grier ren-
dered in 1865, Bennet v. Baker (footnote to 15 Wall. 67),
and the judgment of the Cireuit Court in Chicago, B. & Q.
R. R. Co. v. Page, 1 Biss. 461, 466, decided in 1864. And,
as shown above at pp. 8-9, in Lynch v. Turrish, 247 U.S.
221, decided in June, 1918, this court followed and ap-
proved the ruling in Gray v. Darlington.
It must reasonably be presumed that Congress, when
it proposed the Sixteenth Amendment, and the state
legislatures, when they ratified it, intended to adopt this
judicial interpretation and definition of the word income.
The conclusion is, therefore, fully warranted that
both those who proposed the Sixteenth Amendment and
those who ratified it understood and appreciated the
foree and effect of the decision of this court in Gray
v. Darlington, and acted upon the belief that such a delib-
erate and authoritative definition of ‘‘inecome’’ and *‘eap-
ital’’ for purposes of taxation would constitute at once
the measure and the limitation of the extension of the
power of Congress ‘‘to lay and collect taxes on incomes
. without apportionment,’’ so as not to conflict with
IGOR SS PLETE IIE LEI MG ES LRA HG NET FS
wn
the constitutional provisions requiring direct taxes on
27
property to be apportioned.
C.
Particularly must it be apparent that this was the
understanding of the state legislatures, since they knew
that it was universally held to be the law in the United
States that a gain realized by a trustee upon the sale of
a part of the corpus or principal of a trust fund consti-
tuted capital or principal and not income, and belonged
to the remainderman and not to the life-tenant, when the
life-tenant was, by the express terms of the instrument
creating the trust, entitled to all ‘‘income’’ arising
from the trust estate. Mercer y. Buchanan, 132 Fed.
901, 508, 137 Fed. 1019; Graham’s Estate, 198 Pa. St. 216;
Neel’s Estate (No. 2), 207 Pa. St. 446; Matter of Gerry,
103 N. Y. 445, 450; Thayer vy. Burr, 201 N. Y. 155,
157-8; Boardman vy. Mansfield, 79 Conn. 634; Car-
penter v. Perkins, 83 Conn. 11, 20; Outcault v. Appleby,
36 N. J. Eq. 73, 78; Parker vy. Johnson, 37 N. J. Eq. 366,
368 ; Guthrie’s Trustee v. Akers, 157 Ky. 649, 651; Slocum
v. Ames, 19 R. I. 401; Smith v. Hooper, 95 Md. 16; In re
Armitage (1893), 3 Ch. 337, 346; 28 Eng. & Am. Eneye. of
L. & P. (2nd ed.) p. 917; 39 Cyc. 444; 40 id. 1788. The
rule upon the subject is accurately stated by Prof.
Irvine in his article on ‘‘Trusts’”’ in the Cyclopedia of
Law and Procedure, as follows (vol. 39, p. 444):
‘“‘As instruments creating trusts frequently
provide for the payment of income to one set of
beneficiaries, and the corpus to another set, it often
becomes necessary to decide what is ineluded
within the term ‘capital,’ and what within ‘in-
come.’ In general, the capital or corpus of the
trust estate includes not only the property which
originally comes into the trustee’s hands, but its
—
increase in value and whatever eubsequenthly takes
its place and representa its henee it includes the
money, including the profits, derived from a anle
of stock, bonds, or other property of the truet ex
tate, a common illustration of this being where
the trustee, in order to protect the estate, buys
in pe ted at a foreclosure or other judicial aale
and subsequently reselle it at a profit,’
2M
Parker v. Johnson, 87 N. 3. Faq. 206, 068, was a cone
precisely like the one whieh Prof. Levine designated ae
“a common illustration” of the rule, and the Chancellor
there said, referring to a profit realized upon the sale of
a portion of the principal of a trust estate, that
“The profit [thus made} is not income 1
was made hy the trustee in the process of convert
ing the investment, and, like a premium realized
on the sale of government bonds in which the funds
might be invested, it belongs to the fund.’
The clear distinction between income and capital
made and observed in cases affecting the rights of life
tenants and remaindermen was, it ia proper to as
sume, familiar to most legislators. A large part of the
invested capital of every community ia held in truest enh
ject to legal and equitable life estates with remainder
over. Plainly, therefore, it is reasonable to assume that
those who ratified the Amendment understood the word
“incomes”? in the light of ite settled meaning in one of
the commonest of legal relations.
That this common and familiar distinction did not
directly appertain to taxation, is quite immaterial. In
deed, this court has 60 held. The learned district judge
in Towne v. Eisner, 242 Fed. 702, 704 ef seq., atternpted
to distinguish the rule laid down in Gibbone vy. Mahon,
136 U. 8. 549, in respect of life-tenant and remainder
man, by refusing to give it force and effect in cases in-
volving income taxation. But this court reversed the
my
oo
holding of the district Judge npon this precise pont, and
treated as decisive the cule that the stock dividend there
in question constituted rapital and not income ae between
life tenant and remaimnderman, saying in ite opinion by
Mr. Justice Noles (245 US. at pp. 426):
“Notwithstanding the thoughtful disenzecion
that the cnse received below we cannot doubt that
the dividend was capital as well for the purposes
of the Income Tax Law ac for distribution het ween
tenant for life and remainderman "'
No other reenlt would he in aerordance with logir
And this will at onee be apparent if we asenme, for the
moment, that an imerense remlized hy the sale of a part of
the corpus of a trust estate, is taxable ne income, Under
the settled rule of law, that inerease wonld heowne part
of the capital of the trast and ultimately helong to the
remainderman and not the life tenant
There ia in this snpposititions ease no diffenity in an
derstanding that such an inerense ie easentially capatal
and remains capital when transmnted hy sale inte money,
and the case of the Merchants Loan & Trust Company as
Trustee of Kyersom, No. (8, new ander advisement
presents that very qnestion. When the trnst relation
disassoriates income from capital and places the en
joyment of each in a separate individnal, it ie easy
to perceive that growth of capital assecta ia not an
der snch cireumatances ineome, even when the proeeee
of investment and reinvestment at some period of
time operates to convert the principal inte cash for
reinvestment. But, manifestly, what ia capital and what
is income, az hetween the life-tenant and remainderman
in the case supposed, ie not altered in ita essential char
acter and natare and tarned from one claas inte another
merely because both the remainder and the life estate
a a re a
30
happen to be vested in the same individual at the same
time, which is the case where property is owned outright
by an individual as in the case at bar or by a corporation
as in the Eldorado case, No, 609. Logically, there is in
either of such cases no more justification for requiring
income taxes to be paid out of capital, than there would
be for depriving a life-tenant of a part of his income in
order to pay for a benefit derived by the remainderman,
or in depriving the latter of part of his capital to pay an
alleged income tax, when he is the recipient of no in-
come whatever.
D.
For many years prior to the adoption of the Six-
teenth Amendment, the British courts had held and
have since continued to hold that eapital in any form,
whether the realized increment of value upon the sale
of property by an individual or of capital assets by a
corporation, is not taxable as income under the British
income tax laws which have been in force since 1842.
This British authority is peculiarly important in view
of the well-known fact that American income tax
legislation came to us from England and has always
been in large part patterned after the English enact-
ments (Black on Income Taxes, 4th ed., sec, 30):
and it should, therefore, reasonably be presumed that
both the Sixteenth Amendment and the Income Tax Acts
were framed in the light of the British precedents, and
*“*that Congress, in adopting the language of the English
act, had in mind the constructions given to these words by
the English courts, and intended to incorporate them into
the statute’’ (Interstate Commerce Com. v. B.€ O. RK. R.,
31
145 U.S. 263, 284). See also Interstate Commerce Com.
v. Del, Le d& WR. OR, 220 UL 8. 240, 253-4; McDonald y.
Hovey, 110 U.S. 619, 628.
Both in 199, when the Sixteenth A mendment was pro-
posed by Congress to the several States, and in 1913, when
it was finally ratified, it was the settled law in Great
Britain that the growth or increment in value of invest-
ments, or of the capital assets of a corporation, when real.
ized by sale or other disposition (as distinguished from
profits so realized where such sale is the taxpayer's trade
or business) was principal or capital and not ineome
within the scope of the income taxing laws of Great
Britain and the British Dominions. Assets Co., Ltd.
v. Forbes (1897—Court of Exchequer, Scotland), 3
Tax Cases 542, 048; 24 Rettie 578, 586; Scoble v. Secre-
tary of State for India (1903—House of Lords) [1903] A.
C. 29, affirming [1902] 1 K. B. 494; Californian Copper
Syndicate, Ltd. v. Harris ( 1904— Exchequer, Scotland), 5
Tax Cases 159, 165-6, 167; Taxation Commissioners vy.
Mooney (1907—Privy Council), [1907] A. (. 342, 350;
Hudson's Bay Co., Ltd. v. Stevens (1909—Court of Ap-
peal), 5 Tax Cases 424, 436, 437, 440: Tehran (Johore)
Rubber Syndicate, Ltd. v. Farmer (1910—Exchequer,
Seotland), 5 Tax Cases 658, 664-5; Commissioner of
Taxes v. Melbourne Trust, Ltd. (1914—Privy Council),
[1914] A. C. 1001, 1010,
In Assets Co., Ltd. vy. Forbes, supra, decided in 1897,
Lord Young said:
“*I wish to give expression to the doubt which I
entertain, and which I understand is shared by
Lord Trayner very strongly, as to the cases in
which we hold that a gain made by the sale of
roperty at a price more than was paid for it may
be regarded as income. . . . I should say that I
have really no doubt that any person, or any com-
pany making a trade of purchasing and welling in
vestments, will be liable in Income Tax upon any
profit which ix made by that trade... . Mut it i
another proposition altogether that, where that i
not a trade, « gain or lox upon the purchase andl
re-sale of property comes within the menning o!
the Income Tax Acts. Take even proper traders.
if proper traders ell their old premines and buy
new ones, and sell the old premises at a higher
price than they paid for them, investing in the pur
chase of the site and the erection of new premie: «
the price which they got, 1 «henld say it wae o
totally antenable proposition that anything in «x
cess of what they had paid for the old PTO see
perhaps 20 vears before, and whieh they got at a
better time, that any excess upon the priee whieh
they paid at the better time is income within the
a trade, would then come within the region of In
come Tax.”’
In the case of Californian Copper Syndicate, Ltd. +
Harris, supra, decided in 1904, Lord Justice Cleric stated
the rule as follows:
**It is quite a well settled principle in dealing
With questions of assessment of Income Tax. that
where the owner of an ordinary investment chonees
to realise it, and obtains a greater price for +
than he originally acquired it at, the enhance
Price is not profit in the sense of Scheigle I) of
the Income Tax Act of 1442 assessable t4 Income
Tax. Bat it is equally well established thar «=.
hanced values obtained from realisation or cor
version of securities mar he «6 assessable. where
what is done is not merely a realisation or chang
of investment. bat an act done in what is truly the
CArrring on. or carrring oct. of a business.”
_——
And Lard Trayner conenrring declared that the ease then
before the court was not ‘the enae of a company eelling
part of ite property for a higher price than it had paid
for it, and keeping that price ae part of ite capital, nor a
case of a cnnpany merely changing the investment of jta
“
ne
capital te pecumary advantage’ (5 Taz Caeee at p 167)
In Varatem Commenimer« « Mowncy, oapra, derided
by the Privy Connell in 1977, it appeared that the tax
payer had realized a profit on the eale of a mine in which
he had invested, and it waa held that thie profit wae not
sohbet te tazation, lard Marmnaghten saying that the
Privy Counesilora agreed with the court telow that
“A change in the form of property ty a per
wom whe does not trafic in that kind of property
tannet te regarded aa preelacing inoue ‘acatle
ander the Inevane Taz Acta
The case of Nudes bay Co, Ltd + Stenens, supra.
Aeevwied in the Coart of Agpeal in 10%), again preanted
he Qeestion if as Mhfrt an 42° SHV ING a Very larze
afew sar,* of tax: tat the comet acinerer te the aot ther} prin
“iple, Lard Jaatior Farwell aaying
‘it ia well aettier! that menme. not Capital. ia
tazable arnler the Ineume Tax Arta it in
lear, therefore, that a man who aeile hia land or
pitares, of yeweia. 1a act enargeatle with meame
tax on the gurehase-money of om the differenes
‘wlween the amount ‘hat he gave and the amount
that he rereiverd for them. Bat if matead of deal-
ing with hia property a4 owner he embarka on 4
trae, then fe Genomes hatle ws gay. aot on the
‘Torte Of ale OFlices Wer ourehase oriees, but on
the annual grofita or gains arming from nich ‘rade
M aaeeTanang Weh thew omee< wil ao fonht
‘we Mts enmeuleraton. —
And nm Tetra (Jonare, Rabher tmdivate Lia +
Parmer, repre, deewlerdt the following crear 10) in the
Court of Eaeneqner of Seotiand. where a cabher somoané
= os : eer eERRe yaya
54
sold out all its property at a profit, Lord Salvesen spoke
as follows:
“Tam unable to distinguish the position of the
Appellants from that of a person who acquires
a property by way of investment and who realises
it afterwards at a profit. It is well settled that in
such a case the profit is not part of the person's
annual income liable to be assessed for income tax
but results from an appreciation of his capital.
No doubt if it is part of his business to deal in
land or investments, any profits which in the course
of that business he realises form part of his in
come; but the mere fact that a person or company
has invested funds in the purchase of an estate
which has subsequently appreciated and so hag
realised a profit on his purchase does not make
that profit liable to assessment. Here the Appel.
lant Company was formed primarily to acquire
and develop a certain estate mentioned in the
Memorandum and any other estates suitable for
the cultivation of rubber; and to carry on the
business of developing and cultivating the said es.
tates.
‘‘No doubt power was also taken to sell any
part of the undertaking and property of the Com.
pany; and [ assume that the promoters of the
Syndicate had in view from the first that it might
become expedient to do so; but [ am unable to in
fer from this fact, taken along with the ultimate
sale of the entire assets to a new company, that it
was part of the trade of the Syndicate to purchase
and sell lands.
‘‘The fallacy of the view taken by the Commis
sioners is further apparent from the fact that the
profit which ultimately results from an apprecia-
tion of value is not necessarily referable to the
particular year in which it is realised.
‘*In the case before us it is no doubt true that
the Syndicate only existed a little more than a
year; but that does not in the least affect the ques-
tion whether the profits were made by way of an-
nual income or resulted from appreciation of capi-
tal. Suppose the Company had been in existence
for ten years before it sold its whole property at
a ee ee i
—
a profit, how could it be said that the profit, «eo
made was income of the last year in which it ex
isted?"’
The striking resemblance between the reasoning of
this opinion and that contained in the opinion of thie court
in Gray v. Darlington, 15 Wall. 63, will at once be per
ceived; and like Gray vy, Darlington, the Dritich author
ties make it quite clear that the advanee in the value of
an investment realized otherwise than in the course of
trade or business, ‘is not ineome at all, but merely in
crease of capital and not subject to a tax as income.”
The rule to this effect, thus settled in England anv
Scotland, also prevails in the British Colonies and Dorin
ions. As to Canada, see Pontifex 's Canadian Income
Tax, p. 23, and Breadner (Commissioner of Taxation) om
The Business Profits War Tax Act and The Income War
Tax Act, p. 18; as to Australia, eee Rerlwell's \wstrala
sian Judicial Dictionary (1920), p 76; Moonee ©. Com
missioners of Taration (1905), 3 Commonwealth Law
Rep, 221, 228-9 (Griffith, ©. J), alirmed (1907) A. © 32,
Webb v. Australian Deposit d Mortgage BR, Lad. ¢ 1910).
I) od, 223, 227 (Griffith, ©. J.) ; Bohemians ¢ tah «, Actos
Federal Commissioner of Tasation (DIS), 24 ud WM.
MeLachlan v. Commissioner of Taree, (12) South \we
tralian Law Rep. 188 (Way, Cb): Shiels (Pibhe free
for the Bank of Adelaide) +. Commissioner of Vase:
[1912] id, 175; and as to South Afrioa, eee Marnes’ le
come Tax Practice in South Afriea (1919). pp. 7 0,
Commissioner of Taxes ¥. Roowesrn’s Ketate, Lid. South
African Law Rep. (1918) App. Div. 576
The following extract from Rodwell '« work, abowe re
ferred to, accurately atates the law pon the pount ae bebe.
not only in Australia, to whieh thie hook parteularly
— —
Mw
36
refers, but in all the British Colonies and Dominions as
well (p. 76):
‘*The term ‘income’ as used in N. S. W. Land
and Income Tax Assessment Act, 1898, includes
‘profits, gains, rent, interests, salaries, wages, al-
lowances, premiums, stipends, charges and annui-
ties’ (sect. 68). The proceeds of property sold
are primd facie capital and not income, and the
term ‘profits’ does not include the difference be-
tween the cost price of property and the price at
which it is afterwards sold, unless the buying and
selling of such peasy. is the ordinary business
of the person alleged to be a taxpayer. Per Grif-
fith, C. J.: Mooney v. Commissioners of Taxation
(1905), 3 C. L. R. at pp. 228-299 . , affirmed,
(1907] A.C. 342... ollowed, Bohemians Club
v. Acting Federal Commissioner of Tavation
(1918), 24 C. L. R. 334; McLachlan v. Commis.
sioner of Taxes, Rymill (Public Officer for Ca-
nowie Pastoral Co., Ltd.) v. Commissioner of
Taxes [1912] S. A. L, R. 138,’’ [citing p. 77 also,}
Griffith, C. J. in Webb v. Australian Deposit &
Mortgage Bank, Ltd. (1910), 11 C. L. R. at p. 227,
and Shiels (Public Officer for the Bank o Ade-
es v. Commissioner of Tazes, (1912] S. A. L.
. 175,
It is equally well settled by the decisions of the Brit-
ish courts that under their income tax laws capital losses
are not deductible. Smith vy. Westinghouse Brake Co.,
2 Tax Cas. 357 (1888); Inland Revenue v. Western
Steamship Co., 44 Se. L. R. 715 (1907) ; Royal Insurance
Co. v, Watson, 3 Tax Cas, 500; Stott y. Hoddinott, 7 Tax
Cas. 85; Watney v. Musgrave, 1 Tax Cas. 272.
F.
Prior, therefore, to 1909 when the Sixteenth Amend-
ment was proposed and 1913 when it was finally adopted,
the word ‘‘income’’ was generally understood and had
been quite generally defined as having a meaning distinct
—
—
a “Us Omens > viene ROR
37
from, and exclusive of, the increment of value realized
upon the sale of property held for investment, by an indi-
vidual, or the capital assets of a corporation. ‘‘In the
construction of the language of the Constitution . . . we
are to place ourselves as nearly as possible in the condi-
tion of the men who framed that instrument”? (Ex parte
Bain, 121 U.S. 1, 12) and ‘that which it meant when
adopted it means now”? (South Carolina v. United States,
i99 U.S. 437, 448). So regarded, it is submitted that the
terms of the Sixteenth Amendment could not in the period
from 1909 to 1913 have been understood by Congress or
the state legislatures as including within the power to
tax *‘incomes’’ without apportionment, the power so to
tax the growth or increment of value constituting capital
accretions realized as a result of a change in investments
made otherwise than in the course of the conduct of a
trade or business, Certainly, it was not intended to au-
thorize or permit the taxation of capital under the guise
of taxing income.
If the views expressed by this court subsequent to
1913 be analyzed, this conclusion is strongly reinforced.
The tax laid upon corporations by the Corporation Ex-
cise Tax Act of August 5, 1909, (36 Stat. 11, 112, e. 6, see.
38) was, as shown above, an excise imposed upon the
privilege of doing business in corporate form, and it was
measured by income to the extent and in the special sense
defined in the statute itself. The so-called ‘*income’?’
which measured this tax was not and was not intended to
be the ‘income’? signified and intended in and by the
Sixteenth Amendment, and it has been repeatedly recog-
nized by this court that the senses in which the terms
were used are different in the two cases, The court de-
clared in Stratton’s Independence y. Howbert, 231 U. §.
399, 414, 416, that—
38
**As has been repeatedly remarked, the Corpo-
ration Tax Act of 1909 was not intended to be and
is not in any proper sense an income tax law.’’
See also Flint y. Stone Tracy Co., 220 U. 8. 107, 150,
165; United States v. Whitridge, 231 U. 8. 144, 147, 149;
Anderson v. Forty-Two Broadway Co., 239 U. 8. 69, 72;
Doyle v. Mitchell Brothers Co., 247 U.S. 179, 183; Hays
v. Gauley Mountain Coal Co., 247 U. S. 189, 193, and
United States v. Cleveland C. C. & St. L. Ry. Co., 247
U.S. 195.
Where, on the other hand, a true income tax act was
involved and capital profits were realized upon the change
of an investment under circumstances in no wise related
to the carrying on of business, as in Gray v. Darlington,
15 Wall. 63; or where under a true income tax law cap-
ital profits were realized, not in the course of the busi-
ness, but upon the winding-up and termination thereof,
which is after all but another mode or form of changing
an investment, as was the case in Lynch v. Turrish, 247
U. S. 221, the court in each instance refused to consider
such an increment of value when realized by sale or con-
version as any part of taxable income, and declared that
it remained capital, despite its conversion or transmuta-
tion into cash. And this court has recently stated that
‘‘enrichment through increase in value of capital invest-
ment is not income in any proper meaning of the term”
(Eisner v. Macomber, 252 U. S. at pp. 214-5),
F.
An increase or increment in the value of an invest-
ment, not made or held as a part of any trade or business
transaction, is plainly ‘‘a gain accruing to capital’’ and
a ‘‘growth or mcrement of value in the investment,”’
29
within the definition of the court in Eisner y. Macomber,
supra. Inno proper sense does it proceed from the prop-
erty, as do rents, interest, dividends and other familiar
forms of income; and such a gain, when realized, cannot
properly be described as ‘severed from the eapital’’ for
it remains an integra] part of the capital as much as if it
had not been converted,
Before conversion into money, no one would question
that the property, so held as an investment merely, was
capital, although it then included the enhancement of
value, and that it was not taxable except by the rule of
apportionment. Bearing in mind that the Sixteenth
Amendment is not to be ‘‘extended by loose construc-
tion’? and that it is ‘essential to distinguish between
what is and what is not ‘income’ . . - according to truth
and substance, without regard to form’’ (Eisner y. Ma-
comber, 252 U.S. at p. 206), we must find some distinet
benefit to the taxpayer as income directly attributable to
the conversion, before it can be declared that what the
taxpayer now has is, not merely his capital, but income
instead. Otherwise, the mere fact of conversion, that
is, the form alone, would prevail over the substance and
be made the decisive factor. Yet the court has declared,
although in considering the Act of 1909, that ‘‘subse-
quent change of form by conversion into money did not
change the essence’’ (Doyle y, Mitchell Brothers Co., 247
U.S. at p. 187). Let us suppose the situation of an in-
vestor who desired to change his investments and to
accomplish that result either by sale and new purchase
or by exchange. In each instance, his efforts to change
his capital from one form of investment and transfer it
to another—not as a matter of business or trade, but
solely as a change in the form of his investments—would
= SRO BHO TENT INT iio
40
result in a loss of capital, exacted under the guise of an
income tax, and would constitute a plain penalty upon
capital imposed simply because of a change in the form
of the taxpayer’s capital investments.
Mere conversion of capital investments and change
into money cannot, therefore, be determinative, even
though more money is thus act ually brought to hand than
was originally put into the investment several years be-
fore. Otherwise, Lynch vy. T urrish, 247 U. S. 221, was
wrongly decided. There the taxpayer withdrew, upon
the dissolution of his company, more money than he had
put in, but only as much as his interest in the property
in which he had his investment was then actually worth.
All this was held to be capital and not income, despite
the fact that it was received in money and was the out-
come of a conversion.
It is true that it was stated in the opinion of the court
in Eisner v. Macomber, 252 U. S. at p. 212, that—
‘It is said that a stockholder may sell the new
shares acquired in the stock dividend; and so he
may, if he can find a buyer. It is equally true that
if he does sell, and in doing so realizes a profit,
such profit, like any other, is income, and so far as
it may have arisen since the Sixteenth Amendment
is taxable by Congress without apportionment.”’
This was plainly an obiter dictum, and was probably the
result of concessions made in the briefs of counsel upon
the original hearing and the application for a rehearing
as well as upon the rehearing. The proposition advanced
in argument that realized capital profits were income was
not involved in the case, was not disputed, and, being ir-
relevant, was not disputable. It was advanced by the
taxpayer’s counsel and, naturally, as it was for the advan-
tage of the revenue was not disputed by the Government.
Unless limited to sales of such stock in the course of
41
business transactions, this statement was inconsistent
with Gray v. Darlington, 15 Wall. 63, Gibbons v. Mahon,
136 U. S. 549, and Lynch vy. Turrish, 247 U.S. 221, and
with the decisions of the state courts and of the courts of
(ireat Britain and the British Dominions cited above,
as well as with the reasoning in Eisner y. Macomber it-
self. The inconsistency will be immediately apparent if
we assume that Mrs. Macomber had received the divi-
dend stock in question as a trustee, Such stock would
then, of course, have constituted a part of the principal
of the trust fund and belonged as such to the remainder-
man and not to the life-tenant (Gibbons vy. Mahon, supra) ;
and it would still have constituted part of the corpus or
capital if thereafter turned into cash, and the life-tenant
would, in that event, still be entitled to no participation
whatever in any of the proceeds of the sale. Neverthe-
less, according to the dictum quoted above, an income tax
would have been payable in respect of this conversion of
capital assets and change in the form of the investment of
the trust estate. But, manifestly, the remainderman, who
is not entitled to any income and only to capital, ought not
to be required to pay a tax upon ‘‘income’’; and, equally
plainly, the life-tenant, who is entitled to the whole in-
come but has not received any part of this converted
stock dividend because, as to him, it constitutes capital,
should not be called upon to pay a tax upon gains ac-
cruing to and received by another. This evident anomaly
indicates the fallacy inherent in the passage quoted from
the opinion in Eisner v. Macomber.
The foregoing views have recently found acceptance
and approval in the case of Brewster v. Walsh, decided
on December 16, 1920, by District Judge Thomas of Con-
necticut, 268 Fed. 207, now before this court for review
sub nom. Walsh v. Brewster, No. 742.
42 *
It, therefore, follows that the word ‘‘j
income’’ had 4
well-established, clearly defined and unambiguous mean
ing at the time of the consideration and adoption of the
Sixteenth Amendment, that this meaning excluded real.
ized increase or increment of value
investments, that the
thorize a tax upon
tion realized on cor
on the sale of capital
Sixteenth Amendment does wot an-
capital growth, increment, or aceroe-
version of a permanent investment,
and that if the Income Tax Law of 1916 can be const rued
as imposing such a tax, it is in that respect unconstitu.
tional amd void.
Il.
Tue Ixcome Tax Law or 1916 DOES NOT LEVY A Tax
UPON THE GROWTH OF INCREMENT IN VALUE OF CAPITAL
ASSETS WHEN REALIZED BY SALE.
A.
The Act of 1913 did not tax merease in value of
capital
investments.
The framers of the original Ineo
tober 3, 1913 (¢. 16, 38 Stat. 166
well the rule declared in the ease of Gray vy. Darling-
ton by this court and the English cases cited and dis.
cussed above. Indeed, reference to the debates in Con.
gress will show not only a clear understanding that in-
crement in value of property held for investment was not
in its nature income, but that it was not the intention
of Congress in the Act of 1913 to tax realized increment
of capital investments.
Thus, on April 26, 1913, the Income Tax Bill (H. RB.
3321) was before the House of Representatives as Com-
mittee of the whole House on the state of the Union.
(Congressional Record April 26, 1913.) Mr. Hull (the
me Tax Law of Oc.
) understood perfectly
43
draftsman of the income tax provisions) was explaining
the bill in detail, and with reference to the Sixteenth
Amendment, when the following occurred (Cong. Ree.
vol, 50, part 1, at p. 513):
“Mr. Hull. 1 will say to the gentleman frankly
that it has been held in construing all these laws
that I have observed, that unless the unearned in-
crement is expressly made income it ix not con-
sidered income in any sense of the word but sim-
ply increase of value or capital . . .
Mr, Mann. What I real y wanted to get at was
not that, but whether it would relate back so as to
cover all profit. Su pose a man bought property
many years ago which probably last year was
worth as much as it is this year. He sells it this
year. What are his profits? How does he arrive
at what his profits are?
Mr. Hull. My judgment would be that as to an
eceasional purchase of real estate by one not a
dealer or one making the buying and selling a busi-
ness this bill would we apply to profits on sales
where the land is purchased and sold during the
same year.
Mr. Mann. 1 hope that statement will remain
in the Record.’’
And at page 506 we find:
“Mr. Hull. The rulings of the Treasury De-
pariment and the decisions of the courts of this
country with respect to similar provisions of the
old income tax laws and also the English rules of
construction, all essential portions of which will
be embraced in the Treasury regulations, will make
clear the distinction between taxable profits or in-
come on the one hand and capital or principal on
the other.’’
So far as appears this view as to the Act of 1913 was
not modified by Congress in connection with the Act of
1916. On the contrary, in the debate in the Senate on
August 30, 1916 (53 Cong. Rec., part 13, p. 13407, et seq.)
the question of taxing increase in value of capital invest-
ments was debated and the holding of this court in Gray
v. Darlington read. Thereupon Senator Hitchcock said:
44
“I still am not able to understand it. I will
put a case to the Senator. Suy a man has
pu in a certain year dauke or bonds and
two / egg thereafter there is an advance of $20,000.
Is man just taxed for one year only on the
profit made?
“‘Mr. Clarke of Arkansas: He is not taxed at
all on that because it ceases to be income and be-
comes capital.’’
The entire debate is quoted in the appendix, and
whilst it is somewhat confusing, it is not improbable
that the view of Senator Clarke, that an advance in
value of stocks or bonds was capital, was acquiesced in
by Senate and House.
At any rate, the ruling of this court in Gray v. Darling.
ton was clearly brought to the attention of the Senate in
August, 1916, and nevertheless the language adopted was
substantially the same as that used in the Acts of 1867
and 1913. Surely, if it had been the intention then to
tax increase in value of capital investments, clear and
unambiguous language would have been used, in order to
overcome *‘a presumption, resistless except against an in-
tention imperatively clear’’ (Mr. Justice MeKenna in
Lynch v. Turrish, 247 U. 8. at p. 230).
In neither the Act of 1913, nor the Act of 1916 was
the growth or increment or increase of value of prop-
erty held for investment expressly made income and
taxed as such. As Mr. Hull stated in 1913, the rule
of statutory construction, which he correctly gathered
from the decisions discussed under point Il, supra,
was that ‘‘unless the unearned increment is expressly
made income it is not considered income in any sense of
the word but simply increase of value or capital.”’
Hence, if we had no constitutional provision command-
ing that essentially direct taxes (such as a tax on the
4
proceeds of the sale of property or the substitute there.
for) should be apportioned, the rule of construction would
reasonably be that no part of the proceeds of the sale
of property held for investment and not in connection
with the carrying on of a business or trade would be tax-
able as income unless expressly made so. However,
logically a statute could not make that income which
was not so in its very nature except as fixing a standard
by which to measure a tax. If the original asset as cap-
ital could not be taxed except by the rule of apportion-
ment, then manifestly it should logically follow that the
proceeds of or substitutes for such capital assets were not
taxable exeept by apportionment.
But however this may he, there can be no doubt
that according to many authorities the increment or ac-
eretion in value of capital assets when realized had gen-
erally not been treated as coming within the term ‘‘in-
come”’ unless expressly made so by the taxing statute,
assuming arguendo only that Congress could, as the
British Parliament could, make that income for the pur-
poses of an income tax law which was not in truth and
substance income at all. The statute before the court
does not purport to make such inerement or accretion in-
come; it is very doubtful whether Congress intended to
treat it as such, and it should not now be made «o by ad-
ministrative or judicial interpretation. So far as ap-
pears, Congress had no such specific intent and may have
contemplated and intended quite the contrary.
The principles which should govern this point are
succinctly stated by Mr. Justice McReynolds in the case
of Gould v. Gould, 245 U. S. 151, 153, speaking for the
unanimous court, in the following language :
**In the interpretation of statutes levying taxes
it is the establi rule not to extend their pro-
——— Ca ad ed I ER WA, Ree,
46
visions, by implication, beyond the clear import of
the language used, or to enlarge their operations so
as to embrace matters not specifically pointed out.
In ease of doubt they are construed most strongly
inst the Government, and in favor of the citizen.
United States v. Wigglesworth, 2 Story 369; Amer-
wan Net & Twine Co. v. Worthington, 141 U. 8.
468, 474; Benziger v. United States, 192 U. 8. 38,
55.
“*. . . The use of the word itself in the defini-
tion of ‘income’ causes some obscurity, but we are
unable to assert that alimon ~~ to a divorced
wife under a decree of court falls fairly within any
of the terms employed.’’
If the court was thus unable to assert that annual pay-
ments of alimony received by a divorced wife fell fairly
within the terms of the Income Tax Law of 1913, it must
a fortiori be unable to assert that the realized increment
or accretion of value of property held for investment
falls fairly within any of the terms employed in that act
or in the act of 1916, which in this respect is substantially
the same.
The grave doubts which reasonably exist both as to
the intent of Congress, as well as to the constitutional
power to tax such increment at all except by apportion-
ment, should be resolved in favor of the taxpayer. The
Congress well knew, for it had been repeatedly admon-
ished by this court, that it was bound to express its in-
tention to tax increment of value of property held for
investment in clear and unambiguous language. Thus, in
Eidman v. Martinez, 184 U. 8. 578, 583, Mr. Justice Brown
speaking for the court said:
“It is an old and familiar rule of the English
courts, applicable to all forms of taxation, and
particularly special taxes, that the sovereign is
bound to express its intention to tax in clear and
unambiguous language, and that a liberal construc-
tion be given to words of exception confining the
47
operation of duty. Warrington v. Furbor, 8 Kast,
242, 247; Williams vy. Sangar, 10 Kast, 66, 69;
Denn vy. Diamond, 4 B. & C. 243, 245; Tomkins vy.
Ashby, 6 B. & C. 541; Doe v. Snaith, 8 Bing. 146,
152; Wroughton vy, Turtle, 11 M. & W. 961, 567;
Gurr v. Scudds, 11 Exch. 190, though the rule re-
garding exemptions from general laws may be dif-
ferent. Cooley on Taxation, 146; In Matter of
Enston, 113 N.Y. 174, 177.”’
B.
The changes in phraseology in the Act of 1916 do not
indicate any intent so to broaden the scope of the income
tax as to include realized increment as an item of taxable
imcome.
In the appendix the corresponding relevant portions
of the Acts of 1913 and 1916 are printed in parallel col-
umns, with appropriate variations in type to denote new
matter added and old matter omitted or modified. From
an inspection and comparison of the two acts, it will
appear that the change which has a direct bearing upon
the topic now under discussion was that in the Act of
1916 the phrase ‘‘entire net ineome received in the pre-
ceding calendar year from all sources’’ is used in place
of the phrase in the Act of 1913, ‘entire net income aris-
ing or accruing from all sources in the preceding calen-
dar year.”’
**Received,’’ however, is a word of narrower, not
broader, scope than “arising or accruing.’’ Income
which is earned or due may be said to ‘“‘arise”’ or ‘ac-
cerue’’ and hence be within the Act of 1913, but the same
income would not be within the Act of 1916 unless in fact
received within the year by the taxpayer. Familiar in-
stances are interest on real estate mortgages due late in
= PEPE NE TRO 1 EERE GTA NT: ee a eee EE eT
«oe eens
48
the calendar year but not actually paid until the follow.
ing year, and interest on corporate bonds or other obli-
gations not paid when accrued but subsequently collected.
Instances could be multiplied, but those suggested are
sufficiently typical, and in themselves afford an adequate
explanation for the change in verbiage. Whilst there is,
of course, a shade of difference, the substance is the same
so far as the present question is concerned. Lynch y,
Turrish, 247 U.S. at p. 230, and Maryland Casualty Co. v.
United States, 251 U. S. 342, 345,
In the Act of 1916 a new subdivision (see, 2 subd.
(c), is added as follows:
_ “For the purpose of ascertaining the gain de-
rived from the sale or other disposition of prop-
erty, real, personal, or mixed, acquired before
March first, nineteen hundred and thirteen, the fair
market value of such property as of Mareh first,
nineteen hundred and thirteen, shall be the basis
for determining the amount of such gain derived.”
This subdivision, however, is limited by section 1 and
the preceding subdivision (a) of section 2. By the for-
mer the tax is imposed on ‘‘net income,’’ by the latter net
income is specified and defined in precisely the same
words as in the Act of 1913. Subdivision (c) must, there-
fore, be construed as applicable only to such gains derived
from sales or dealings in property as are taxed, Subdi-
vision (c) does not impose any tax, but merely states the
basis of determining or computing the tax already im-
posed.
A new subdivision (Fifth) of section 5 is added allow.
ing as an additional deduction—
‘*In transactions entered into for profit bat not
connected with his (the taxpayer's) business or
trade, the losses actually sustained therein during
the year to an amount not exceeding the profits
arising therefrom.’’
—
Under the Act of 1913 there is no similar provision.
Mente v. Eisner, 266 Fed. 161 (C. C. A. 2ed Cir; cortio:
rari denied by this court October Lith, 1990, No. 447).
Far from this provision indicating any infest to tas
realized increment, the only reasonable inference ie di-
rectly to the contrary, The two acts plainly taxed as is-
come gains derived from transactions entered inte fer
profit, in the purchase and sale of ral of personal
property outside of the taxpayer's regular becineces,
or otherwise emtered into for promt, each as the
usual speculations in securities on a stock exchange, prw-
duce exchange, board of trade, otc, or speculative par.
chases and sales of real estate as distingwiched from im-
vestments, It is a matter of common knowledge Ukat the
great bulk of transactions on the exchanges are of this
speculative nature, and they are entirely distinet from
the purchase or acquisition of securities for pormament
investment. Under the Act of 1913 losses were eet do
ductible unless the taxpayer coukd establich that the ae
ture of his transactions was such as to comstitwte © trade”
and come within the term
es '
a ea. sustained dering the year ie
Subdivision Fifth of scetion 5 was caavted te enable
the taxpayer to deduct losses resulting from ottlhes
“transactions entered into for profit bet got comaeuted
with his business or trade."’ Thc ehemtty excbmded teens
actions entered into for investmeet and eet arodhe dy font
profit,
It was, therefore, evidently the inteet in the Act of
1916 to make the dedhactiome allowed pur) passow willy the
constituents of taxable income The fact that Domace cet
side of business wre allowed only foo thee Domeithed eethend
50
is strongly indicative that capital profits realized on the
sale of investments were not being taxed.
Cc,
The well settled meaning of the word “income” in
common speech, as exclusive of realized increment, should
be deemed to be the meaning of that word in the Act of
1916,
The intent of the act ix plainly to tax the annually
recurrent income of a taxpayer, The great mass of
the people who invest their savings in real estate and in
the purchase of investment securitics productive of in-
come certainly do not regard realized increase of value
in such investments ax “income”. The realization of
profit through sale is rarely the controlling motive in
making such investments, They are not strictly entered
into for profit but for investment. Safety and interest or
dividends are the impelling factors, Under the Act of
1916 a loss sustained by the taxpayer on the sale of his
home is not deductible, Is it not almost inconceivable
that Congress would have taxed as income the profit real.
ined by « householder or investor upon the sale of his
home or of the securitics representing his savings, with.
out using language imperatively clear, when not permit.
ting the deduction of losses in similar transactions!
The rule to be applied to the construction of the Acts
of 1913 and 1916 ix stated in Black on Income Taxes, 4th
Exl, See. 30, p. 26, as follows:
“It is another and ancient rale in the const ruc-
tion of statutes that the meaning of a doubtful
worl or rase may be ascertained by references
the ng of other words or phrases with which
it is associated, and that, where several things are
referred to they are presumed to be of the same
clase when connected 4 copulative
51
unless a contrary intent clearly appears. For ex-
ample all the acts of Congress on the subject of
income taxation, from 1862 to the present time,
have associated together the words ‘gains’,
‘profits’ and ‘income’ as descriptive of the sub-
ject taxed, and the same is true of the income tax
aws of some of the States. These words may be
traced far back in the history of English taxa-
tion. The original income tax law of that coun-
try, enacted in 1799 imposed a tax on ‘income’ by
that name, but the acts of 1842 and 1853 intro-
duced the associated terms ‘profits and gains’
whence they were apparently borrowed by Con-
gress in framing the Act of 1862 aid have since
persisted in use. Applying the rule above stated
we are justified in asserting the following prin-
ciples as applicable to the interpretation of the
phrase in question. If it is doubtful whether or
hot a particular fund or acquisition is taxable as
‘income’ under the statute, it is not taxable unless
it is income in the nature of ‘gain’ or ‘profit’.
If any item is clearly included in the description
of ‘gains’ yet it is not taxable unless it is a gain
in the nature of incomes or profits. And although
the disputed item may be certainly a profit in one
sense of the word, yet it is not taxable unless it be
a profit accruing by way of gain or income.”
D.
The provisions of the Act of 1916 with regard to de-
ductions are inconsistent with the inclusion of realized in-
crement as an item of taxable income,
Broadly speaking the deductions allowed are all such
as relate to true income and not such as relate to isolated
transactions and instances of the realization of increment
of value on investments,
Under section 5 of the Act of 1916, the ** Deductions
Allowed"’ include (see appendix for quotation in full)
the following:
le i en i eh. eee =~ “ee ~ ©
52
(1) Necessary expenses of the business or trade;
(2) interest; (3) taxes; (4) ‘‘losses actually sus-
tained during the year incurred in his business or
trade’’ . . . (5) losses to an amount not exceeding
the profit in ‘transactions entered into for profit’’;
(6) worthless debts; (7) ‘‘a reasonable allowance
for the exhaustion, wear and tear of property aris-
ing out of its use or employment in the business
or trade’’, and (8) a special provision for oil and
gas wells.
Then follow a prohibition of allowance of deductions,
namely,
‘*No deduction shall be allowed for any amount
paid out for new buildings, permanent improve-
ments, or betterments,’’
and a further prohibition of the deduction of the expense
of restoring property for which an allowance was or had
been made. e
It is further to be noted that in the usual case of the
sale of a taxpayer’s home, or other real property, free-
hold or leasehold, held for investment, which is not used
in his business or trade, there is no deduction allowed
for exhaustion, wear and tear, and that no loss on the
sale of a home, or of property acquired by gift or inherit-
ance is deductible in fixing net income.
If it was intended to tax realized increment of value
in investment property, there was a remarkable over-
sight in failing to provide for its taxation in the many
instances where after the increment of value has accrued
title to the property passed by gift, devise, bequest, or in-
heritance, and the property was then sold, without reali-
zation of further advance in value, by the donee, devisee,
legatee, or heir. Obviously, by a mere gift of property
— CORRE LVR EVEN
VIP: EI NTR ET ae ET RET II NEN OER OUT
—
which had greatly increased in value the collection of any
tax on the amount of such increase could be prevented.
53
E.
Full meaning and effect can be given to all the terms
and provisions of the Act of 1916 through the construc-
tion advocated, namely, that realized increment of value
was not included as an item of taxable income.
It is submitted that it has been decided by this court
that the general expression ‘gains, profits and income
from any source whatever’’, or its equivalent, contained
in the acts of 1867 and 1913, did not include realized in-
crease or increment of value of property held for invest-
ment, and that these general words could have ample
scope if held to embrace only gains and profits properly
and accurately within the current meaning of the term
“income.’’ So likewise as to the term ‘sales or dealings
in property,’’ it is submitted that its true intent and
meaning is ‘‘income derived from sales or dealings in
property’’, and does not include the conversion or trans-
mutation into money or other property of a capital in-
vestment because the proceeds do not represent income.
In other words, the controlling factor is not the sale or
the dealing in property, for we are not discussing an ex-
cise tax, but income realized from such a transaction, that
is to say, what is properly to be denominated income as
distinguished from capital.
The words of the statute have an apt and appropriate
function with respect to trade or business transactions
and speculations, which will give adequate force and ef-
fect to the provision without necessarily including a gain
—
realized upon the increase in value of a capital invest-
ment. The distinction between the former and the latter
is quite clear. Annual net profits of a business or trade
are ascertained after deducting all the expenses and losses
of the business from the gross aggregate of profits and
other income, 2nd this surplus alone constitutes the an-
nual net income of such business or trade, regardless of
the value of particular assets or of the profit or loss on
particular transactions. But a gain derived from an iso-
lated sale of an investment is in a totally different class
and to be treated according to different rules. It is not
part of the annual or other net income of a taxpayer in
any proper or reasonable sense, but a profit resulting
from an isolated and unusual transaction.
All the other terms of section 2 (a) of the act clearly
relate to true income, and do not cover realized incre-
54
ment.
F.
The construction adopted and enforced by the Com-
missioner of Internal Revenue results in hardship, injus-
tice and unreasonable discrimination among classes of
taxpayers.
As examples of hardship and inequality attention may
be called to the following instances:
(a) While in the case of a going business, or in trans-
actions entered into for profit, losses are deductible, they
are not deductible in other transactions, however much
capital may thereby have become impaired.
(b) In the case of property held for a long period by
an investor, or as an investment of trust funds by a fidu-
ciary, losses are not deductible under the Act of 1916 be-
a 4
7
: ag ~
REALE DRE MGI OOTP ECON GBs. POAT S HF eons 5 ¥ wey
55
cause such transactions are not ‘‘entered into for profit.’’
Hence, in the usual instance of losses incurred in one
year on the sale of investments and profits realized in
other years, or vice versa, the losses could not be deducted
but the profits would be taxed and not allowed to be offset
as against losses theretofore sustained.
(c) Under the progressively graded rates of tax, a
tax upon the realization of the increment of value may
be levied at a rate out of all proportion to the increment if
apportioned pro rata during the period of accrual. This
point has become of the greatest practical importance un-
der the act of 1918. That it results in great hardship and
injustice under the Act of 1917 is shown by the enormous
tax exacted from the Ryerson Trust (No. 608) where the
$700,000 profit conceded to have accrued over a period
of four years and to belong to an undetermined number
of beneficiaries, was taxed as a single income for one
year without any deductions,
The sole theory upon which income taxes on incre-
ment of value are being levied is that such increment
is not taxable as income until realized, and that, although
it accrues from year to year during a series of years,
it is not unjust that it should be taxed when actually real-
lized by sale. This theory might work fairly if the inere-
ment were then apportioned over the period of accrual,
retroactively, with appropriate provision for deductions
of decrease in value of similar investments. This would
be both fair and feasible. The act before the court, how-
ever, has no such provisions. The graded rates of super-
tax make the tax, when the increment of value is real-
ized, out of all proportion as compared with the rate dur-
ing the period of accrual, so that, as in the Ryerson case,
the tax was at least ten times higher than it would have
been if apportioned to the years when it actually accrued
Se ey ee ae ee TE RE pape: > ewe ELTA a one _ 6 5D
56
among the beneficiaries entitled to the capital profit real-
ized.
The rule to be applied under such circumstances js
stated by the court in Knowlton vy. Moore, 178 U.8. 41, 77,
as follows:
‘*We are, therefore, bound to give heed to the
rule, that where a particular construction of a
statute will occasion great inconvenience or pro-
duce inequality and injustice, that view is to be
avoided if another and more reasonable interpreta-
tion is present in the statute. Bate Refrigerating
Co. v. Sulzeberger, 157 U.S. 1, 37; Wilson v. Rous-
seau, 4 How. 646, 680; Bloomer vy. McQuewan, 14
How. 539, 553; Blake v. National Banks, 23 Wall.
307, 320; United States v. Kirby, 7 Wall. 482, 486.""
G.
The contention of the Government based on practical
construction is not well founded.
A contention made by the Government in the Ryerson
Trustee and Eldorado cases (Nos. 608 and 609) will
doubtless be repeated in the case at bar, namely, that the
Treasury Department in 1914-1915 ruled that realized in-
crement was included under the Act of 1913 as an item of
taxable income and assessed and collected income tax
accordingly, and that this practical construction must be
deemed to have been adopted by Congress by the enact-
ment of the Act of 1916 in substantially the same lan-
guage as the Act of 1913. This contention, however, is
somewhat inconsistent with the Government's further
position that by substituting the word “‘received’’ for
the words ‘‘arising and accruing’? the whole scope and
meaning of the act were in this respect clearly changed.
In answer to the contention based on practical con-
struction it is submitted that there is no authority in
57
support of this contention applicable to the present situ-
ation, namely, a ruling by a department of the Govern-
ment in direct violation of a decision of this court upon
the exact point of construction in question, rendered many
years prior to the departmental ruling, and never ques-
tioned by the courts but followed by a decision of this
court directly to the contrary of the departmental ruling.
Gray Vv. Darlington, the authority of which has never been
questioned, is directly the opposite of the departmental
ruling on this point, and in 1918 this court in Lyuch v.
Turrish, construing the Act of 1913 with respect to which
such ruling was made, held the ruling to be erroneous.
Furthermore, the very point as to the adoption of a de-
partmental construction by the subsequent reenactment
of the law so construed was necessarily involved, though
not passed upon by this court, in Gray v. Darlington.
The first federal income tax law enacted by Congress was
that of 1861 (12 Stat. 309). This law was re-enacted, with
changes in rate, in 1862 (12 Stat. 473); a similar law
with further changes in rate was enacted in 1864 (13
Stat. 223, 281) and amended in 1865 (13 Stat. 469-479),
and in 1867 (14 Stat. 471, 477), sections 116 and 117
of the act of 1864 were amended in the form quoted above
at page 7 of this brief. In the appendix, the relevant
portions of each of these earlier acts are printed. On
comparing their phraseology, it will be noted that
the four acts in so far as relevant are substantially iden-
tical. The last one of the series, that of 1867, was con-
strued in Gray v. Darlington, decided in 1872. At the
time of its enactment the practical construction, of taxing
realized increment as income, had been enforced for some
five or six years. As early as May, 1863, the Commis.
sioner of Internal Revenue had ruled as follows:
a a
58
**No. 110. Gains or profits realized from the
sale of property during the year 1862, which prop-
erty was purchased before the excise law went into
yy shall be returned as income for the year
1 vee
** Losses incurred in the prosecution of the busi-
ness are a fair offset to gains derived from business
but not from those portions of income derived from
fixed investments, such as bonds, mortgages, rents,
and the like.’’ ( Rulings of Internal Revenue I*e--
partment, 1871, Government Printing Office.) *
Yet this court in Gray v. Darlington, decided in 1872,
ignored these definite and long established rulings of the
Department.
That an erroneous construction by a department is
in no way binding on the court was not only recognized
in Lynch v. Turrish and Southern Pacific Co. v. Lowe,
247 U. 8. 221 and 330, but directly ruled in Merritt vy.
Cameron, 137 U. 8. 542, 552; United States v. Tanner, 147
U. 8. 661, 663; Houghton v. Payne, 194 U. 8. 88; Savings
Bank vy. United States, 19 Wall. 227, and Studebaker v.
Perry, 184 U. 8. 258, 269. In the case last cited the court
said:
**The doctrine invoked is a useful one but its
application should be restricted to cases in which
the construction involved is really one of doubt
and where those to be affected have relied on the
practical construction, and rights have accrued by
reason of such reliance.’”’
° were the In-
teres Jo Department publiched by the Office of
59
IV.
As THE SALE OR CONVERSION OF THE STOCK OF THE Goop-
RICH COMPANY REPRESENTED AN ACTUAL L088, NO PART OF
THE PROCEEDS WAS TAXABLE AS INCOME OF THE TAXPAYER.
Assuming, arguendo, that increase in value of capital
when realized by sale is taxable as income under the Six-
feenth Amendment and the Act of 1916, it is nevertheless
submitted that no part of the proceeds of the sale of the
stock of the Goodrich Company was taxable because such
sale resulted not in any gain but in an actual loss to the
taxpayer.
The record in the ease at bar conclusively establishes
that the plaintiff did not receive or realize any gain or
profit whatever from the sale of the shares of the capital
stock of the Goodrich Company, but as matter of fact
sustained a loss or diminution of capital value of $22,253,
instead of a gain or profit of $120,700 (pp. 8, 9).
Section 2 of the Income Tax Law of 1916 provides
that ‘‘the net income of a taxable person shall include
gains, profits, and income derived from sales or dealings
in property,’’ etc. The addition of the word **income”’
to the words ‘gains, profits,” however, added nothing,
and never should have been employed, for it served no
useful purpose. It would, of course, be absurd to define
income as being income. Mr. Justice McReynolds pointed
out in the case of Gould v. Gould, 245 U. 8. 151, 153, with
respect to the word ‘‘income”’ in the Act of October 3,
1913, 38 Stat. 144, 166, that ‘‘the use of the word itself
in the definition of ‘income’ causes some obscurity.’’
PO OO PEWS af yd
60
There should be no difficulty in concluding that within
long recognized canons of statutory construction the gen-
eral word ‘‘income’’ following the enumeration of the
specific words ‘‘gains’’ and ‘‘profits’’ must be restricted
to things of the same kind, ejusdem generis, as those spe-
cifically enumerated. As Mr. Justice Lurton said in
United States v. Stever, 222 U. S. 167, 174:
‘*In such circumstances, unless there is a clear
manifestation to the contrary, general words, not
specific or limited, should be construed as appli-
cable to cases or matters of like kind with those
described by the particular words.”’
This view is strongly reinforced by the fact that in
the same section of the Act of Congress, the provision of
section 2 in relation to March first, 1913, speaks only of
gain, and that no reference is made to profits or income.
The maxim expressio unius est exclusio alterius would
seem to be clearly applicable. The language employed
would then exclude ‘‘profits and income,’’ if they mean
something other or broader than ‘‘gains,’’ and must be
confined to the single subject of ‘‘gains.’’ Such was un-
doubtedly the intention, for the provision actually reads
as follows:
**(c) For the purpose of ascertaining the gain
derived from the sale or other disposition of prop-
erty, real, personal, or mixed, acquired before
March first, nineteen hundred and thirteen, the
fair market price or value of such property as of
March first, nineteen hundred and thirteen, shall
be the basis for determining the amount of such
gain derived.’’
Obviously if the words ‘‘net income’’ in the preceding
subdivision (a) of the same section had been intended to
mean something different from ‘‘gains’’ and ‘‘profits’’,
RY PN z eS eT EIT PLS OUT Sey EE Se
—e
the same terminology would have been used and repeated
in subdivision (c).
It follows that, if we are to reject the rule of ejusdem
generis and to hold that by the use of the word ‘‘income,’’
as employed in subdivision (a) of section 2, it was intended
61
to reach and cover something different from ‘*gains’’ or
‘‘profits,’’ then it must necessarily follow that income
other than a gain does not come within the purview of
subdivision (c) of the same section because the term ‘‘in-
come’’ was not repeated there, and that there was, there-
fore, no authority to apply the standard of market price
or value as of March first, 1913, as distinguished from
the market price or value when the plaintiff acquired the
stock of the New York Goodrich Company in May, 1912.
It would then result that if there was no gain at all, but
in fact and truth an actual loss or diminution of capital,
as in the case at bar, the statutory provision enacted
“for the purpose of ascertaining the gain derived from
the sale,’’ ete., and “determining the amount of such
gain derived”? would not apply.
To hold otherwise would be to re-write the statute in
a way quite beyond the power of any court and to at-
tribute to the law-making power an intent which would
in many instances be unfair, unjust and oppressive to tax-
payers who had received no gain or profit whatever and,
indeed, nothing that would come reasonably within the
“natural and obvious sense”’ of the word income authori-
tatively defined as ‘‘the gain derived from capital, from
labor, or from both combined”’ (Doyle v. Mitchell
Brothers Co., 247 U.S. at p. 185; Eisner vy. Macomber,
252 U. S. at p. 207). The Closing clause of the amended
62
provision, namely, that it ‘shall be the basis for deter.
mining the amount of such gain derived,” plainly evi.
dences the idea that the test or standard fixed in the sub
division should apply only where there was a“ gam de
rived,”’ and not where there was actually a loss sustained
Congress could not arbitrarily create a fietitions
**gain,’’ where none in fact existed, in order to levy an
income tax on the transaction, when in final analysis such
4 tax would have to be paid clearly out of diminished
capital and therefore be an unapportioned property tax
as distinguished from an income tax. To constitute a gain
there must, of course, be a realization of profit by sale
over the cost of the property when acquired. The two
dates—of acquisition and sale—and the value on each of
them are essential clemonts, Congress could pot fix an
arbitrary date of acquisition so as to charge the tax
payer with a fictitious cost any more than it could fix as
arbitrary date of sale or conversion. Plainly, the par
pose of the provision in question was te eogtegate the
amount of gain accruing after the adoption of the Six
teenth Amendment from any gain accruing before, only
when a gain had actually accrued and been realized
The fact that the date of March first, 1912, ix adopted
in the Act of 1916 likewise for the parpore of determining
a loss, that is, ‘‘the basis for determining the amoent of
such loss sustained,”’ is immaterial, because the allow
ance of the deduction of losses actually sustained ic
wholly a statutory concession, and Congress might, ae it
did in the Income Tax Act of 1913, « 16, 38 Stat. 108,
limit the losses allowable and exelade altogether as o
deduction capital losses not sustained ip carrying on &
business or trade.
tar payable wabely im peepuut of waguitiel wn wat aif Whe gin
cools of capetal Al amy fate, There aie womanly ~ garenn
dowbts wpom that score.” fe sath @ ease Whe walle ie Mie
Comet is fo wend & comecibacinon wiivth weigit gousdlew o eames
even of chombttal cometituticonalliny (Eval Saline & Somes
ond Brewery, 31 U. 8. 200, 230; Veined Staten « dee Pare
Mog, 241 U, & 204, 01; Dedied States © Beliewer &
Hedvoe Co, 130, & TE), tered he nae 4 sometnnrion
Which Will wrod came dommes, ill suecnadbite er
Moteonee cupaallly Wel cette be Me val) Wied ae aeaite
as to the intent of & tae lew willl he sesuud te Bese af
the taxpayer, CGonld ©, Gowld, 245 0 & ER. Badwee «
Martiore, 184 U_ &. S08, Se.
Maren, it bhwe tewm the Renge wettaihibiclhind putin ait
this court to Hienit gemeead terme, cath ae thw wore Oe
comme” tm the came at Dine, ce ae nll he Rend fe inuhmeltion
PET ERROR, oF am ald rorenOnIN. ded Re wumeloneN @
Matate aevwglling te He epiieit and gull wnomdiing Re ite
Metter whemewee the bettew wohl vumdin it ew amie ow
Wo eemmmame Ue Climgiwee datemedind be Rae wee” gee” when
Wee im Fart need ret an eumeed eee
Thee, ie DM edied Siete © Kote, Wel ot eee We
Aeectinnw Wehd Ae@inud he velo on the Poilhowang Mongpenge
AB Dawe child gemmiee 4 comedies Henaeroiees
——
64
tion. General terms should be so limited in their
application as not to lead to injustice, oppression,
or an absurd consequence. It will always, there.
fore, be presumed that the legislature intended ex.
ceptions to its language, which would avoid re-
sults of this character. The reason of the law in
such cases should prevail over its letter.’’
See also Stratton’s Independence v. Howbert, 231 U.S.
399, 414; Hawaii y. Mankichi, 190 U. 8. 197, 212; * aly
Trimty Church v. United States, 143 U. S. 457, 4oy;
Pickett v. United States, 216 U. 8. 456, 461; Knowlton y.
Moore, 178 U.S. 41, 77; United States v. Palmer, 3
Wheat. 610, 631.
It follows, therefore, that it is reasonably to be pre-
sumed that Congress did not intend to levy a tax on any-
thing except ‘‘gains’’ actually received by the taxpayer.
The standard of March first, 1913, was adopted and fol-
lowed solely for the benefit of the taxpayer, so as to ex-
clude ‘‘gains’’ which had accrued prior to that date. As-
suming that increase in value of capital investments
could be and was intended to be taxed as income, then the
clause now in question was a concession to the taxpayer
so as to exclude from taxation as income increases in
value which had accrued prior to March first, 1913.
ConcLusion.
For the reasons indicated above, it is submitted (1)
that growth, increment, or accretion in value of property
held for investment and then sold is essentially capital and
not income, (2) that it was not the intention of Con-
gress to tax such growth, increment, or accretion in value
in and by the Act of 1916, and (3) that the test of market
price or value on March first, 1913, is applicable only
iN i La hw ee ete ees a
65
where there has in fact been a gain, and not where there
has been in fact a loss of capital.
The judgment of the court below should, therefore, be
reversed.
Washington, February 28, 1921.
WituiaM D. Gururie,
Lanepon P. Marvin,
iTenry M. Warp,
Hersert Pops,
Rusn C. Butter,
Of counsel for plaintiff in error.
67
APPENDIX.
Comparison or Income Tax Acts or 1913 anv 1916.
The language of the Act of 1913 omitted in the Act of 1916 is placed in
brackets and underscored; the new matter in the Act of 1916 is italicized.
Matter common to both acts is in same type.
Act of 1913, (38 Stat. 166).
‘*A. Suspivision 1.
That there shall be levied,
assessed, collected and paid
annually upon the entire net
income [arising or accruing
from all sources in the pre-
ceding calendar year to]
every citizen of the United
States . . . a tax of 1 per
centum [per annum] upon
such income . . .; and a like
tax shall be assessed, levied,
collected, and paid annually
upon the entire net income
[from all property owned
and of every business, trade
or profession carried on in]
the United States by Tper-
sons residing elsewhere
B. That, subject only to
such exemptions and deduc-
tions as are hereinafter al-
lowed, the net income of a
taxable person shall include
gains, profits, and income
derived from
salaries, wages, or com-
pensation for personal ser-
vice of whatever kind and in
whatever form paid,
or from professions, voca-
tions, businesses, trade, com-
merce, or sales, or dealings
in property, whether real or
Act of 1916, (39 Stat. 756).
**See. 1 (a)
That there shall be levied,
assessed, collected, and paid
ainually upon the entire net
income received in the pre-
ceding calendar year from
all sources by every individ-
wal, a citizen or resident of
the United States, a tax of
two per centum upon such
income; and a like tax shall
be levied, assessed, collected,
and paid annually upon the
entire net income received in
the preceding calendar year
from all sources within the
United States by every indi-
vidual, a nonresident alien
See. 2(a) That, subject
only to such exemption» and
deductions as are hereinaf-
ter allowed, the net income
of a taxable person shall in-
clude gains, profits, and in-
come derived from
salaries, wages, or com-
pensation for personal ser-
vice of whatever kind and in
whatever form paid,
or from professions, voca-
tions, businesses, trade, com-
merece, or sales, or dealings
in property, whether real or
68
Appendix.
personal, growing out of the
ownership or use of or in-
terest in real or personal
property,
also from interest, rent,
dividends, securities, or the
transaction of any (lawful)
business carried on for gain
or profit, or gains or profits
peel income derived from any
source whatever, [includin
the income from but n e
value of property acquired
ea) eats
personal, growing out of the
ownership or use of or inter.
est in real or personal prop-
erty,
also from interest, rent.
dividends, securities, or the
transaction of any business
carried on for gain or profit,
or gains or profits and in.
come derived from any
source whatever, . . ,
(b) Income received by
estates of deceased persons
during the period of admin-
istration or settlement of the
estate, shall be subject to the
normal and additional tax
and taxed to their estates,
and also such income of es.
tates or any kind of property
held in trust, including such
income accumulated in trust
for the benefit of unborn or
unascertained persons, or
persons with contingent in-
terests, and income held for
future distribution under the
terms of the will or trust
shall be likewise taxed, the
tax in each instance, except
when the income is returned
for the purpose of the tax
by the beneficiary, to be
assessed to the executor, ad-
ministrator, or trustee, as
the case may be. . .
PR)
— a
Appendix.
“That in computing net
meome for the purpose of
the [normal] tax there shall
be allowed as deductions:
"9
(c) For the purpose of
ascertammmg the im de-
rived from the sale or other
disposition of property, real,
personal, or mixed, acquired
hefore March first, nineteen
hundred and thirteen, the
fair market price or value of
such property as of Marc
first, nineteen hundred and
thirteen, shall be the basis
for determining the amount
of such gain derived.
Sec. 4. The following in-
come shall be exempt from
the provisions of this title:
The proceeds of life insur-
ance policies . . . the value
of property acquired by gift,
quest, devise, or descent
(but the income from such
property shall be cluded as
mcome); interest upon the
obligations of a State . . =
the compensation of the
present President of the
United States . . . and the
Judges . . . and the com-
pensation of all officers . . .
of a State “yf
**Depuctions ALLowep
Sec. 5... That in computing
net income in the case of a
citizen or resident of the
United States
(a) For the purpose of
the tax there shall be al-
lowed as deductions
70
Appendix.
first, the necessary ex- First. The necessary ex-
penses actually paid in car- penses actually in car-
ryiag on any business * * rying on any or
r ss
incurred in trade or arising
from fires, storms, [or] ship-
wreck, [and] not compen-
sated insurance or
otherwise ;’’
Second. All interest paid
withiz the year * * *
Third, Taxes * * *
Fourth, Losses actually
sustained during the year,
incurred in his business or
trade, or arising from fires,
storms, shipwreck, or other
casualty, and from theft,
when —, oy ws not
compensa or insur-
ance or otherwise ;’’
Provided, That for the pur-
pose of ascertaining the loss
sustained from the sale or
other disposition of prop-
erty, real,personal,or mixed,
acquired before March first,
nineteen hundred and thir-
teen, the fair market price
or value of such property as
of March first, nineteen hun-
dred and thirteen, shall be
the basis for determining
the amount of such loss sus-
tained ;
Fifth. In transactions en-
tered into for profit but not
connected with his business
or trade, the losses actually
sustained therein during the
year to an amount not ex-
ceeding the profits arising
therefrom.
fifth, debts due to the tax-
payer actually ascertained
to be worthless and charged
off (within) the year.
sixth, A reasonable allow-
ance for the exhaustion,
wear and tear of property
arising out of its use or em-
ployment in the business.
[Provi That] no de-
duction be allowed for
any amount paid out for new
buildings, permanent im-
provements, or betterments,
made to increase the value
of any property or estate,
Sizth. Debts due to the
taxpayer actually ascer-
tained to be worthless and
charged off during the year.
Seventh. A reasonable al-
lowance for the exhaustion,
wear and tear of property
arising out of its use or em-
ployment in the business or
trade;
Non-Resident Aliens.
Sec. 6. That in computing
net income in the case of a
nonresident alien (a) For
the purpose of the tax there
shall be allowed as deduc-
tions—First, The necessary
expenses actually paid in
carrying on any business or
trade within the U nited
States.
Second. The proportion
of all interest paid . . . om
his indebtedness. . . .
Third. Tazes.. .
Fourth. Losses actually
sustained during the year,
incurred in business or trade
conducted by him within the
United States . . . arising
from fires, storms, ship-
wreck, or other casualt
from theft . .
iemnintin
6 eee
Hi ie
Hind t? THF
F
it rRiH
2
The tax herein imposed
upon (annual) gains, profits,
and income not falling under
the foregoing and not re-
turned and paid by virtue of
the foregoing shall be
assessed by personal return.
73
Appendix.
No deduction shall be al-
lowed for any amount paid
out for new buildings, per-
manent improvements, or
hetterments, made to in-
crease the value of any prop-
erty or estate,
and no deduction shall be
made for any amount of ex-
pense of restoring property
or making qood the exhaus-
tron thereof for which an al-
lowance is or has been made.
The tax herein imposed
upen gains, profits and in-
come not falling under the
foregoing, and not returned
and paid by virtue of the
foregoing, shall be assessed
by personal return... .
Text or tHe Iscome Tax Acts of trae Crem War
penton, 1861-1867, so Fan as RELEVANT.
be levied,
and paid, upon the annual income of
i ing in the United Staten, whether suck Income
is derived from any kind of property
profession, trade, or vocation ;
ried on in the United or elsewheve, or from
any other source whatever, . . . a tax of three per
centem on the amount of such excess .. above
eight hundred dollars. . . .”’
In this act the only provision for deductions is as
follows :
a
i
a
“* Provided, That, in estimating said income, all
national, state, or local taxes assessed upon
property. from which the income is derived, shall
deducted.”
Act of July Ist, 1862, 12 Stat. 432, 473:
“Geo. 9. . .. That i
collected, r i annually, upon the annual gains,
fF
Fe
&
that above quoted from the act of 1861 for the deduction
of taxes, and a new provision for the deduction of sal-
aries of officers or persons in the service of the United
States including senators, representatives and delegates,
Appendix.
and of interest, dividends, ete. on which tax has been paid
at the source.
Act of June 30, 1864, 13 Stat. 223, 281:
“See 116. . . . That there shall be levied,
collected, and paid annually upon the + mom om,
profits, or income of ov person residing within
the United States . 4 whether derived from
any kind of property, rents, interests, dividends,
salaries, or from any profession, trade, .
ment, or voration, carried on in the United States
or elsewhere, or from any other source whatever,
except as hereinafter mentioned . . . a duty
of five per eentum on the excess over six hundred
dollars . . . And provided, further, That net
profits realized by sales of real estate purchased
within the year for which income is estimated,
shall be chargeable as income, and losses on sales
of real estate purchased within the year, for which
income is estimated, shall he deducted from the
income of such year.”’
“See. 117. . . . In estimating the annual
gains, profits, or income of any person . . .
there shal! be included and assessed as part of the
income of such person for each year . . . all
meome or gains derived from t rehase and
sale of stocks or other property, real or personal,
and the increased value of live «tock, whether sold
oron hand .. ."
In the Act of 1964 there is, in sec. 117, a further pro.
vision, similar in language to that in the Act of 1862, for
the deduction of taxes, of official salaries, and of incomc
tax paid at the source. A new provision is added for the
deduction of rent of premises from which income is de-
rived (p. 282) and of interest on encumbrances thereon,
and the amount paid for ordinary repairs, and the pro-
vision follows, repeated in all the subsequent acts from
that of 1865 to and including the Act of 1918:
» ae Be.
i ee
BE REI eT RAN SF Ss
RAO rl ss og en
76
Appendix.
“But no deduction shall be made for any
amount paid out for new buildings, permanent im-
provements, or betterments, made to increase the
value of any property or estate.”’
Act of March 3, 1865, 13, Stat. 469, 479:
Sections 116 and 117 of the Act of 1864 were re-enact-
ing (so far as pertinent) in substantially identical lan-
guage with that above quoted.
Act of March 2, 1867, 14 Stat. 471, 477:
Section 116 of the Act of 1864 as amended by the Act
of 1865 was further amended by striking out all after
the enacting clause and inserting (478) :
‘‘That there shall be levied, collected, and paid
annually upon the gains, profits, and income of
every person residing in the United States . .
whether derived from any kind of proverty, rents,
interest, dividends, or salaries, or from any pro-
fession, trade, employment, or vocation, carried on
in the United States, or elsewhere, or from any
other source whatever, a tax of five per centum.
9
Section 117 was amended by striking out all after the
enacting clause and inserting:
‘That in estimating the gains, profits, and in-
come of any person, there shall be included all in-
come derived from interest upon notes, bonds, and
other securities of the United States; profits real-
ized within the year from sales of real estate
purchased within the year or within two years
previous to the year for which income was esti-
mated ... the amount of all premium on gold and
coupons; the amount of sales of live stock, sugar,
wool . . . or other vegetable or other productions,
77
Appendix.
come tax, as hereinbefore provided, all . . . taxes
... Shall be deducted . . . losses actually sustained
during the year arising from fires, shipwreck, or
incurred in trade, and debts ascertained to be
worthless, but excluding all estimated depreciation
of values and losses within the year on sales of
real estate purchased two years previous to the
year for which income is estimated, . . . Provided
that no deduction shall be made for any amount
paid out for new buildings, permanent improve-
ments or betterments, made to increase the value
of any property or estate.’’
78
Appendix.
DepatEs 1N Concress, Acts or 1912 anp 1916,
On April 26, 1913, the Income Tax Bill (H. R. 3321)
was before the House of Representatives as Committee
of the Whole House on the State of the Union. Cong.
Ree., Vol. 50, pt. 1, Apl. 26, 1913. Mr. Hull (the reputed
author of the income tax provisions) was explaining the
bill in detail and with reference to the Sixteenth Amend-
ment. At page 513:
‘“‘Mr. Hull. I will say to the gentleman frankly
that it has been held in construing all these laws
that I have observed, that unless the unearned in-
crement is expressly made income it is not consid-
ered income in any sense of the word but simply
increase of value or capital. * * *
Mr, Mann. What I really wanted to get at was
not that, but whether it would relate back so as to
cover all profit. Suppose a man bought property
many years ago which probably last year was
worth as much as it is this year. He sells it this
year. What are his profits? How does he arrive
at what his profits are?
Mr. Hull, My judgment would be that as to
an occasional purchase of real estate by one not a
dealer or one making the buying and selling a
business this bill would only apply to profits on
sales where the land is purchased and sold during
the same year.
Mr. Mann. TI hope that statement will remain
in the Record.’’
and at page 506:
““Mr. Hull. The rulings of the Treasury De-
partment and the decisions of the courts of this
country with respect to similar provisions of the
old income tax laws and also the English rules of
construction, all essential portions of which will
be embraced in the Treasury regulations, will make
clear the distinction between taxable profits or in-
come on the one hand and capital or principal on
the other.’’
79
Appendix.
In the Senate debates over the Act of 1916 (H. R. Bill
No. 16763) the following proceedings appear. On August
26th, 1916, the Senate resumed consideration of the House
Bill. (Cong. Ree. Vol. 53, part 13, p. 13262).
In the bill as it passed the House the provision with
respect to the basis of ascertaining gains on sales (now
subd. (c) supra, p. 69) read as follows (p. 13262):
““(c) Of the gain derived or loss sustained
from the sale of real estate, stocks, bonds, securi-
ties, or other property, acquired before March 1,
1913, not bought and sold in the course of trade by
the taxpayer, only such proportion shall be in-
cluded as the time between March 1, 1913, and the
date of sale bears to the entire time between the
date of acquisition and the date of sale.’’
This provision was stricken out in the Senate without
debate and the Senate Committee’s amendment adopted,
Viz. :
‘*(c) For the purpose of ascertaining the gain
derived from the sale or other disposition of prop-
erty real, personal, or mixed, acquired before
March 1, 1913, the fair market price or value of
such property as of March 1, 1913, shall be the
basis for determining the araount of such gain de-
rived.’’
The Senate adopted as a further amendment the fol-
lowing proviso (page 13263, col. 2):
‘*Provided, that for the purpose of ascertain-
ing the amount of such loss or losses sustained in
trade or speculative transactions not in trade from
the same or any kind of property acquired before
March 1, 1913, the fair market price or value of
such property as of March 1, 1913, shall be the
basis for determining the amount of such loss or
losses sustained.”’
80
Appendix.
The following amendment was offered by the Senate
Committee (page 13263) :
“Fifth. In transactions entered into for profit,
but not connected with his business or trade, the
losses actually sustained therein during the year
to an amount not exceeding the profits arising
therefrom.’’ (This amendment was adopted in
conference and became part of the law.)
Here followed a long debate on the subject between
Senators O’Gorman, Williams, McCumber and others in
which the question of profits and losses on the sale of
capital investments was not discussed but the debate was
confined to speculative transactions and ordinary deal-
ings, for example, on the stock market. Finally, the
amendment to the amendment was agreed to in the fol-
lowing form :—
“Fifth. In lawful business transactions en-
tered into but not connected with his regular busi-
ness or trade, the losses actually sustained therein
during the year.”’ (Cong. Ree., p. 13266. )
In the course of the debate above referred to, at page
13264, Senator Williams said;
“‘Mr. President, the present law admits of no
deductions whatsoever in these cases. We thought
that was rather too drastic. These are transac.
tions entered into for profit but not connected with
the taxpayer’s business or trade. It is intended
to provide for speculative profits and speculative
losses."’
On August 30th, 1916, the debate on the bill (H. R.
16763, was resumed by the Senate as Committee on the
Whole, Cong. Ree., Vol. 53, part 13, 64th Cong., 1st Sess.,
p. 13407) and Senator Clarke of Arkansas offered the
following amendment :-—
(e) ‘*For the purpose of ascertaining the gain
derived from the sale or other disposition of real
81
Appendix.
property, the profits realized within the year from
the sale or other disposition of any real estate
purchased within two years previous to the close
of the year for which such income is estimated,
shall be the basis for determining the amount of
such gain so derived from such sale or other dis-
position thereof.”’
Senator Williams, in behalf of the Committee in
charge of the bill, then said :—
‘‘With that amendment adopted there ought
to be inserted the same amendment where the
measure of losses sustained is to be considered
because it involves the same question. I, there-
fore, ask unanimous consent that, if adopted, the
same amendment shall be handed to the clerks at
the desk by the Senator from Arkansas to be in-
serted at the other place in the bill where it would
be relevant.’’
“Mr. Chamberlain: I should like to know the
purpose of the amendment and why it is offered
now after the committee amendment has been
adopted.’’
**Mr. Clarke of Arkansas: I am very glad to
explain it. The purpose of the amendment for
which this has been substituted was to fix a date
when the profits of an investment should cease to
be income and become capital. The amendment
adopted heretofore fixed March 1, 1913, as that
date and made it a permanent date, so that no
matter how long this Act might remain in force,
that would be the date from which the investment
as capital would be considered and all profits in-
tervening would be income. This has been one of
the troublesome questions in tax legislation. In
1867 Congress fixed the period within which real
estate investments should be treated as income at
two years. The matter was brought to the Su-
preme Court in the case of Gray vs. Darlington,
Fifteenth Wallace, where it was held that profits
during the current year were properly treated as
income, that if the investment inured for a longer
period it became merged in capital and it was not
proper to fix it as income. That feature was car-
ried into the subsequent income tax law down
to the one passed in 1894, The last income tax
left it out entirely, so that the only part of the
profit on real estate investment or any other ip.
vestment for that matter, which should become
profit for the purpose of being treated as income,
would accrue within the current year. The pur-
pose of this Act is to adopt as an approved rule
two years as against real estate investments, that
is to say, investments made in real estate and not
consummated by a subsequent sale for a period
greater than two years, shall be treated as no part
of the income but are to be taken as a part of the
loss and profit of that character of transaction and
be permitted to pass as increased capital. If a sale
occurred any time within the two years, the profit
on the transaction would be treated as income and
accounted for accordingly. It fixes a date that
travels along with the law instead of fixing abso-
lutely a day, which was the first of March, 1913.
That would have involved the necessity of making
an assessment every time an income-tax return was
made with a view of determining whether or not
in the meantime some profit had not attached to it.
The one is a sensible, forcible rule and the other
is an exceedingly inconvenient one which does not
in all cases do justice because it might turn out
that some investments would produce no profit
whatever. No provision is made for taking care
of that contingency.’
**Mr. Hitchcock : According to what I heard of
the amendment read, it differs from the amendment
which the Senate adopted also in this respect that
the amendment adopted by the Senate includes not
only real estate but also personal and mixed prop-
erty. I should like to know what becomes of the
profit on personal or mixed property.”’
‘“‘Mr. Clarke of Arkansas: On personal prop-
erty any profit made during the current year will be
accounted for as income. Profit not made on that
83
Appendix.
character of property during the year or rather
realized by the sale, would not be treated as in-
come. That is the universal rule.’’
“Mr. Hitchcock: Is there any provision for
that in the bill?’’
“Mr. Clarke of Arkansas: The first section of
the bill provides:
(a) That there shall be levied, assessed, col-
lected and paid annually upon the entire net in-
come received in the preceding calendar year from
all sources by every individual a citizen or resident
of the United States, a tax of two percent upon
such income.
That language was deemed sufficient in the
case of Gray vs. Darlington and fixed the period of
the annual accounting. If the Senator will permit
me I will read the syllabus in that case which will
make much clearer than I have been able to do, the
point I am seeking to present to the Senate.
It is the case of Gray vs. Darlington reported
in Fifteenth Wallace, page 63:
The advance in the value of personal property
during a series of years does not constitute the
gains, profits or income of any one particular year
of the series although the entire amount of the
advance be at one time turned into money by a
sale of the property. Accordingly when bonds of
the United States were sold by the owner, after
being held by him four years, at an advance of
Twenty thousand dollars over their cost to him,
it was held that this amount was not taxable as
‘gains, profits or income’ for the owner for the
year in which the sale was made under the Amend-
atory Internal Revenue Act of March 2, 1867
* * * At page 66 the Court said:
The mere fact that property has advanced in
value between the date of its acquisition and sale
does not authorize the imposition of the tax on
the amount of the advance. Mere advance in
value in no sense constitutes the gains, profits or
income specified by the statute. It constitutes
- can be treated merely as increase of eapi-
tal.
Appendix.
That is my answer to the inquiry of the Sena.
tor from N sad
“Mr. Hiteheoek: I stil] am not able to under.
stand it. I will put a case to the Senator. Sup-
pose a man has purchased in a certain year stocks
or bonds and two years thereafter there is an ad.
vance of $20,000. Is the man just taxed for one
year only on the profit made?”’
“Mr. Clarke of Arkansas: He is not taxed at
that because it ceases to be income aml be-
ing the man upon the P
sale of real estate withi and not tax-
ing him upon the profit the purchase
and sale of securities?’
“Mr. Clarke of Arkansas: That always has
carried as a discrimination in the law. What-
n is it ought to be confined to the
ing. There is
a distinction
“‘Mr. Williams: Real estate is not a live asset
and is not generally bought and sold within one
ear.’’
4 “*Mr. Hitchcock: I do not think that answers
the question at all. Wh should we exempt from
the income tax the promt a man makes upon the
purchase and sale of stocks and bonds? Why
should they not be included with real estate just
as they were originally included in this para-
| had
“Mr. Clarke: They are included now if the
purchase and sale is made within a year. That is
the law. The Supreme Court of the United States
answered that question and held that it is a part
of his capital and a tax cannot be levied upon it.”’
“Mr. Hitchcock: I am at a loss to see why the
inerease in the value of real estate is not a part of
the capital. ”
85
Appendix.
“*Mr. Clarke of Arkansas: That matter may be
i some day and determined to the contrary,
but at present the decision of the Supreme Court
seems to treat it as a valid provision. There are
numerous grounds upon which the distinction be-
tween real and personal property can be estab-
lished where one rule of taxation applies in one
ease and another in another. Bonds pass very fre-
quently and very rapidly, many times, whereas
as the Senator from Mississippi suggests, that is
not the rule in the case of real property.”
“Mr. Hitcheock: It seems to me we are pro-
posing to exempt from taxation some or most of
the enormous profits made in this country. For
instance during the last year or two perfectly
prodigious incomes have been derived by men
through successful speculation in the purchase and
sale of stocks and bonds and the incomes derived
from the purchase and sale of real estate are in-
significant by comparison. I do not like to assent
to exempting these profits while continuing to
tax profits on real estate.’’
“Mr. Clarke of Arkansas: The Senator misun-
derstands me if he thinks I am trying to exempt
their profits from taxation. I simply want to es-
tablish a rule that applies in every other character
of taxation provided for in this bill and that is
the annual accounting. That is what was done in
this particular case. The tax collector in New
York collected an income tax of $20,000 upon an
increase on bonds that the taxpayer had been hold-
ing for four years. He paid the tax under a pro-
test and sued the collector for it and that is the
way this particular lawsuit was decided and like
every other lawsuit will be decided— . . .”
*‘Mr. Chamberlain: I am frank to say I really
do not understand the effect of this amendment.
There was a good deal of discussion over this par-
ticular amendment, | will say to the Senator, and
it involves two other amendments which I sup-
posed, and those who think with me on the subject
supposed, had been settled. This seems to change
the whole proposition and before it is acted Upon
I should like to have the matter go over until to
morrow, it involving three amendments as | sug
gested.’’
“Mr. Clarke of Arkansas: I have no objection
to that course. The matter was submitted to the
Senator from Alabama (Mr Underwood) who
proposed the amendment which is now offered as
a substitate.’’
“Presiding Officer: Is there objection to
poning the consideration of this question until to.
morrow?
“Mr. Williams: I have no objection, although
I wish it could be disposed of now. The Senator
from Alabama who drew the amendment which
is w the bill now has agreed to this amendment
to ie aenmnine I think the amendment to the
amendment helps the amendment itself very much
but I have no objection to its going over.
** The Presiding Officer : If there is no ob jection,
it will be postponed until tomorrow."’
The subsequent debates in the Senate and the House
of Representatives do not appear to throw any light upon
the intention of Congress in regard to capital profits
(7157)
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.