Defendants Brief — Walsh v. Brewster

FiLwD

FFB 28 192]

JAMES D. MANER,

CLERK

Supreme Court of tbe United States.

Octoper Term, 1920.

No. 742.

JAMES J. WALSH, United States Collector of Internal Revenue for the

District of Connecticut,

Plaintiff in Error.

9.

FREDERICK F. BREWSTER,

Defendant in Error.

Wait or Error To roe District Court or THe UnitTep STATES FOR THE

District or ConneEcticort.

BRIEF AND ARGUMENT FOR DEFENDANT In ERROR.

Wituram D. Gurnarie,

Henry F. Parmeces,

Grorece D. Warrovs,

Baray Mouvn,

Of counsel for Defendant in Error.

TABLE OF CASES.

All Red Line, Ltd., In re the (British Columbia), Westerly Weeki”

Reports, 1920, Vol. I, MUNG E AN Se0 cdexebeesersadeseccsce.. 12

Armitage, In re (1993), 3 Ch.D. 337.......................... 10

Assets Co., Ltd., v. Forbes, 3 Tax Cases 542, 24 Rettie 578.0 12

Boardman v. Mansfield, 79 Conn. 634......................... 9

Bohemians Club v. Acting Federal Commissioner of Taxation (1918)

24 Commonwealth Law Reps. 334....................... 12

Californian Copper Syndicate, Ltd., v. Harris, 5 Tax Cases 150. 12

Commissioner of Taxes y. Booyesen's Estate, Ltd., So. African Law

Reps. (1918) App. Div. 576...................._ uke 12

Commissioner of Taxes v. Melbourne Tri- t, Ltd. (1914), A.C. 1001.) 2

Doyle v. Mitchell Brothers, 247 U.8.179 .......... : >

Eisner v. Macomber, 252 U. 8.1899... sisi«i«w 3,9, 13, 14, 15, 16

Evans v. Gore, 253 U.8.245.................... ; +

Goodrich v. Edwards, No. 663. ...... Is

Gould v. Gould, 245U.8.151.........000........... ern

Gray v. Darlington, 15 Wall. 63....................__ — y

Hudson's Bay Co., Ltd., v. Stevens, 5 Tax Cases 424... 12

Jordan v. Jordan, 192 Mass. 337..................._.. = .

Lynch v Turrish, 247 U.S. 221....................... 911

Matter of Gerry, 103 N. Y.445........................ 10

Mente v. Fisner. C. C. A., 2nd Cir. 266 Fed. 161. . ene 8

Merchants’ Loan and Trust Co. vy. Smietanka, No. 608... _. 1

McLachlan v. Commissioner of Taxes (1912) South Australian Law

oe a ee CEE EE OT ot as ean —

Mooney v. Commissioners (1905) 3 Commonwealth Law Rep. 221,

aGivmed (1907) A. C. 342......................... 12

Neel's Estate (No. 2) 207 Pa. St.446.................._. 10

Outeault v. Appleby, 36 N. J. Ss hin vos owes 4

’ Parker v. Johnson, 37 N. J. 8 ee nes

Scoble v. Secretary of Stace for India (1903) A. C. 299, affirming (1903)

BoE MEE RE Meena IS J peeee bebe ae

j Shiels v. Commissioner of Taxes (1912) South Australian Law Reps.,

; MC SST Mi tbe Ve gets donde ted ooo loo yk baaran 12

5 Slocum v. Ames, 19 R.1.401......................... 10

Smith v. Hooper, 95 Md. 16.......................... ~ 2

Stratton’s Independence vy. Howbert, 231 U. 8. 399............. wus

3 Taxation Commissioners v. Mooney (1907) A. C. 342... , 12

Trebrau (Johore) Rubber Syndicate, Ltd., v. Farmer, 5 Tax Cases 658 12

: Webb v. Australian Deposit & Mortgage Bank, Ltd. (1910), 11 Com-

ttn tatty nwheritin >a Snel 12

Whitney v. Phoenix, 4 Redf.180........................._... ioe 2

- am FRE LE ENS OE PR er ee es e

SUPREME COURT or THE UNITED STATES

Octoner Term, 1920

No. 742.

a

JAMES J. WALSH, United States Collector of Internal Revenue for the

District of the State of Connecticut,

Plaintiff in Error.

re.

FREDERICK F. BREWSTER,

Defendant in Error

Wait or Error ro tar District Court or THE UNITED States ror THe

District oF Cowrnecticrr.

BRIEF FOR THE DEFENDANT IN ERRor.

This is a writ of error to the District Court of the

United States for the District of Connecticut to review

a judgment for the defendant in error (the plaintiff

below) rendered December 16th, 1920. The case was

tried, without a jury, on the pleadings, and on a stipu-

lated statement of facts. The court below filed an

opinion (Record p. 18.)

STATEMENT.

The Record presents the constitutiona} question

the increase in value of corporate bonds,

are sold. The case differs from Merchant's Loan and

Trust Company r. Smietanka, No. 608. of the present

..

2

term, in that the defendant in error (the plaintiff below)

was @ natural person who owned the bonds in question

directly for his own benefit, and not in trust. It is

stipulated, and found by the court below that he was

in no way “engaged in the business of buying or selling

stocks and bonds, otherwise than occasionally making

court below, that we state them here concisely and

(a) In 1899, the defendant in error acquired as an

investment, $191,000 in face value of bonds of Inter.

national Navigation Company, a domestic corporation

for $191,000. On March 1, 1913, based on market

quotations at 794, the market value of these bonds was

sold them during the year 1916, for their face value

$191,000, their cost in 1899. Based on this transaction

a tax was assessed on $39,155.00 as income, this being

the difference between the market value of the bonds

on March 1, 1913, and the sum received therefor when

sold.

(b) In 1906 the defendant in error acquired as an

investment $257,000.00 in face value of bonds of Inter-

national Mercantile Marine Company, as the court

below finds, at a cost of $231,300.00. On March 1

1913, based on market quotations at 64, the market

value of these bonds was $164,480.00. These honds

were also retained by the defendant in error as an in.

a

3

vestment from 1906 until he sold them during the year

: 1916 in part at 10734 and in part at 10714 for the sum of

$276,150.00. On this transaction a tax was assessed on

$111,670.00 as income, this representing the difference

between the March 1, 1913, market value and the sum

received.

(c) The defendant in error received during the

year 1916 a stock dividend declared against a surplus,

in part earned after March 1, 1913, from Standard Oil

Company of California. A tax was assessed upon this

dividend stock, which defendant in error had not sold,

as constituting income to the amount of $12,019.41.

This is the identical stock dividend passed upon by this

court in Eisner v. Macomber, 252 U.S. 189.

The total amount of tax based upon these three

transactions, amounting to $17,756. 79, was paid to the

plaintiff in error as Collector of Internal Revenue, in

the following manner: the sum of $67.66 constituted a

conceded over-payment of normal tax which was due

to the defendant in error: the balance, $17,689.13, was

paid to the plaintiff in error under protest, and an

appeal taken to the Commissioner of Internal Revenue,

which was denied and suit was thereafter brought. In

the court below, the plaintiff below (the defendant in

error), claimed that in so far as the Income Tax Act of

1916 purported to tax such investment increment as in-

come, it Was unconstitutional and that in any event the

act should not be so construed as to tax as income any-

thing in excess of the difference between cost and sale

price of investments. The court below sustained the

defendant in error on the constitutional question and

since the defendant in error had realized a sum in

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tax on property, and not coming within the provision

of the Sixteenth Amendment.

5. Notwithstanding the construction placed there-

on by the Commissioner of Internal Revenue, the In-

come Tax Law of 1916 does not purport to tax the

proceeds of the sale of a capital investment or any part

thereof as income.

ARGUMENT

I.

Bonps art Property wirnovr REFERENCE 10

Cost on Market Vatur. Tue BONDS THEMSELVEs

ARE THEIR Owner's Capiral Assets, axp ais Capt-

TAL. INTEREST THEREIN Is Nor LIMITED 1O THEIR

Cost, on TO THEIR VALUE As DETERMINED BY Mar-

KET QUOTATIONS ON a Date Fixep py AN ACT oF

CONGREss.

value as capital to its cost, or to its market value on

March 1, 1913. It is his capital, the thing itself. in

its entirety. His house is his capital, used to shelter

himself and his family. His bonds are capital, pur-

chased

sea

Investment bonds, not their cost or former market

value, are capital. Their regular recurrent interest

payments, not the fluctuations of market values, are

income.

The trader in houses or bonds, on the contrary,

has a cash capital. He buys, not a Capital asset to

provide a home or an income for his own use, but a

house, or bond, to be sold at the market; his capital

asset in each transaction is the amount of cash capi-

tal expended from the working capital of his business,

and his income is the difference between his aggregate

gains and losses less the expenses of his business, coy.

ering the period of the year.

This distinction between transactions of a trader

and an investor is recognized in the cases hereinafter

cited, and in our own legislation.

The Income Tax Law of 1913 (38 Stats. 167, Ch.

16, Sec. II B), permitted the offset of losses in trade

to determine net taxable income, but did not permit

an investor to offset realized losses. Mente v. Eisner,

C.C.A. 2nd Cir. 226 Fed. 161.

The Income Tax Law of 1916 (39 Stats. 759) per-

mitted one, in transactions apart from his business, to

offset his losses but only to the amount of his gains in

similar transactions.

The distinction is constantly applied in excise taxes

applicable only to business.

The defendant in error’s bonds, therefore, as long

as he retained them, were his property, unaffected by

the fluctuations in their market value. As his property,

they were capital assets in their entirety on the days

he sold them. The value of his capital was the mar-

ket value of the bonds on the days when sold. Each

8

:

Prsieennwes..

i

hy

'

)

sale resulted in a transmutation of capital from bonds

to cash to the amount of their exact value on that

day.

IT.

INCREASE IN VALUE OF PROPERTY HELD AS In-

VESTMENT Is Nort INcomeE.

“Enrichment through increase in value of

capital investment is not income in any proper

meaning of the term.” Eisner v. Macomber,

252 U.S. 189, 214-215.

“Mere advance in value in no sense consti-

tutes the gain, profits, or income specified by the

statute. It constitutes and can be treated

merely as an increase of capital.”” Gray v. Dar-

lington, 15 Wall. 63, 66. Affirmed in Lynch ».

Turrish, 247 U.S, 221.

IIT.

THE SALE OF AN INVESTMENT REALIZING AN In-

CREASE IN VALUE Dogs Nor CREATE, OR RESULT IN

THE DERIVATION OR RECEIPT OF, INCOME.

This question had frequently arisen between bene-

ficiaries of trust funds who were entitled to entire net

incomes for life, and trustees and remaindermen, and

prior to the adoption of the Sixteenth Amendment, it

had been uniformly held that the realized increase in

value of investments which were sold, were not income

but principal. Boardman v. Mansfield, 79 Conn. 634;

Parker y. Johnson, 37 N. J. Eq. 366; Outcault v. Ap-

pleby, 36 N J. Eq. 74, 78: Smith v. Hooper, 95 Md. 16:

a

iD

In ve Armitage, (BON) AON PD S87, Whitney Phop

WIN, A Red, WO: Matter of Gerry, JOAN Y 445; Noel's

Mstite (No 2), 207 Pa & 46, Slavum » Ames, 19

RL A401; Sordan » Jordan, 197 Mass. 447,

In Stratton’ s | ndependence » Howhert, 2400 409,

this court plainly recognizes that the mere transi

lation of property inte cash does net result i taxable

neotne Speaking by Mr fustion Mitney (pape A,

415)

“Th is tet correct, from: either the Hheoretiog|

Of the practionl standpoint, to say that a nity

MY COPpOration: ig tert engaged in business, bey

18 merely Occtpied in Converting its Capital nccets

from one form inte another The sale oulright

ofa mining property might be fairly deseribed ns

“mere conversion of the capital trom lund inte

money Wat when a COMPANY Is Cigging: pits,

sinking shafts, Hinneling, drifting, Stoping, dill

iniyy, hastings, and hoisting ores, it ie employing

: capital and labor in Hransiuting a part of the

4 really into personalty, and putting i inte nar

5 ketable form The very process of mining is,

IN A Sense, equivalent in its resulle te A otmann

facturing process” (Halies ons )

Sa nee -

I the case at bar there Is nothing but a mere con

version of the Capital from bonds inte money, the court

below having expressly found that the defendant in

error was in no way engaged in the business of bnyiny

and selling securities, beyond oceasionally buying for

investment and occasionally selling for the purpose of

changing the character Of his investments The facts

in the case at bar do not materially differ from the

facts in Gray v, Darlington, 1S Wall. 63. The applicable

statute in that case, the Income Tax Law of 1867,

Dit Ne oh ta eae a

“3

ili ia a a

laid a tak “pon the pains, Prolite, atl ecm of eves y

person whether derived From any beitnwd oof prep

erty. . or from any other coupes whats ver’ OF the

realized advance in value of the lends i Gray Dry

linglon was incon, tanifestly it wae tawable Wei

was income, i was deriverd ring the year when a

was realized, as cleatly it wae not derived before reali

zation. The question of anny Aistinetionn any Heap

hetween the word “derived” in the Act of Od wel

“received” in the Act of ION tay be drones tT Vie

only question ig as te the meaning of the word ay

comes” in the Sixteenth Atmendimnent, which je taily

one Of the words included in the Ve finnitiony of the stibyedt

of tax in the Act of IRO7, that ic “pains, profite, aad

meome™”. TE the realized advances in Value of inveet

ments does not come within the definition of inecnne

as used in the Act of 1BO7, it News tet comme within the

meaning Of the word as used in the Saxteenth Arend

ment

The mere fact that property has walvancedd

in vale between the date Of its wernisition and

Sale ewes tyes authorize the rnposition of the

fax on the amenint of the swslyvanee Mere ad

VANCE In Vvalie in ney cenee Constitiites the pains,

profits, on imeorne specifiod by the statute It

constitutes and can be treated] merely as yn

Crease of Capital” Gray » Darlington, supra, at

page 66

In Lynch Turrish, PAT US, 221, 230, the above

passaye from the opinion by Mr. Justice Field in (way

v, Darlington IS Quoted, and to the quotation the ornurt

adds, “This case has not sines heen questioned of mer

ified."

EE ee a aa erie i i een Sania ae

12

It so appears that under the decisions of this court,

the sale of an investment realizing an increase in Value

ceipt of income. This, of necessity, follows from the

unquestionable proposition that the property in invest.

ments are the investments themselves whether the in-

vestments be lands, chattels, bonds or stocks.

The decisions in this court are in accord with those

in the English and Colonial courts which, without

exception, hold that the realized advance in value of

investment property is not income taxable under acts

which tax income without exception. Assets Co. Lid.

v. Forbes, 3 Tax Cases 542, 24 Rettie 578; Scoble »v.

v. Mooney (1907) A. C. 342; Hudson's Bay Co., Lid., ».

Syndicate, Lid., v. Farmer, 5 Tax Cases 658; Commis-

sioner of Taxes y. Melbourne Trust, Lid., (1914)

A. C. 1001; Mooney v. Commissioners (1905) 3 Com-

(1910), 11 Commonwealth Law Reps. 223; Bohemians

Club v. Acting Federal Commissioner of Taxation (1918)

24 Commonwealth Law Reps. 334; McLachlan ».

Commissioner of Taxes (1912) South Australian Law

Reps. 138; Shiels y. Commissioner of Taxes (1912)

South Australian Law Reps. 175; Commissioner of

Taxes ». Booye.en's Estate, Lid., So. African Law Reps.

(1918) App. Div. 576; In re the All Red Line, Lid.

(British Columbia) Westerly Weekly Reports, 1920,

Vol. I, p. 1030.

+o wR

13

IV.

CONSTRUED TO TAX as INCOME ANY PART OF THE

PROCEEDS OF THE SALE OF A CAPITAL INVESTMENT,

THE INCOME Tax Law or 1916, is TO THAT EXTENT

INVALID AS IN CONFLICT WITH ARTICLE I, SEcTION 2,

CLAUSE 3, AND Artic.e I, SECTION 9, CLAUSE 4 OF

THE CONSTITUTION, BEING A Direct Tax on Prop-

ERTY, AND NOT ComMING WITHIN THE PROVISION OF

THE SIXTEENTH AMENDMENT.

The scope of the Sixteenth Amendment has been

definitely determined by this court.

limitations alone that power can be lawfully

exercised." Eisner y. Macomber, 252 VU. S.

“Thus the genesis and words of the Amend-

ment unite in showing that it does not extend

—

one source or another. And we have «eo held in

other cases.” Evans v. Gore, 253 U. §& 245,

261-262.

14

In order then to preserve the proper force and effect

of the clauses in Article I, relative to direct taxation,

the Sixteenth Amendment must not be so construed

as to permit the direct taxation of property without

apportionment, by including in the definition of the

word income, realized capital.

“The fundamental relation of ‘capital’ to

‘income’ has been much discussed by econo.

mists, the former being likened to the tree or the

land, the latter to the fruit or the crop; the

former depicted as a reservoir supplied from

springs, the latter as the outlet stream, to be

measured by its flow during a period of time.

For the present purpose we require only a clear

definition of the term ‘income,’ as used in com-

mon speech, in order to determine its meaning

in the Amendment; and, having formed also a

correct judgment as to the nature of a stock

dividend, we shall find it easy to decide the

matter at issue.” Lisner yp. Macomber, supra,

pages 206-207.

The clear definition of the term “income,” as used

in common speech at the time of the adoption of the

Sixteenth Amendment, certainly did not include any

part of the principal value of lands, chattels or invest-

ment bonds. The expression “common speech” used

by this court does not mean ignorant speech. Further.

more, the amendment was adopted after the meaning

of the word income had been well established by the

decisions of this court and many state courts which we

15

have cited, and the decisions of the British courts,

uniformly holding that the proceeds of the sale of a

capital investment are wholly capital, though sold at

an advance over initial cost.

In Eisner v. Macomber, supra, in applying the

definition adopted in Stratton's Independence v. How-

beri, supra, and Doyle v. Mitchell Brothers, 247 U.S.

179, 185, “income may be defined as the gain derived

from capital, from labor, or from both combined,”

this court added the following explanation (page 207):

“Derived — from — capital’; — ‘the gain

derived — from — capital,’ etc. Here we have the

essential matter; not a gain accruing to capital,

not a growth or increment of value in the invest.

ment; but a gain, a profit, something of exchange-

able value, proceeding from the property, severed

from the capital, however invested or employed,

and coming in, being ‘derived,’ that is, received or

drawn by the recipient (the taxpayer) for his

separate use, benefit and disposal :— that is income

derived from property. Nothing else answers

the description.”

In the case at bar the tax was laid upon “a gain

accruing to capital,” “a growth or increment of value

in the investment.” There was not a gain, a profit,

something of exchangeable value proceeding from the

Property, severed from the capital. The tax was laid

on the capital itself, the exact equivalent in value of

the bonds, no part of which were income.

The court states, Eisner v. Macomber, supra.

page 213:

“Yet, without selling, the shareholder, unless

possessed of other resources, has not the where-

Nothing could more y

to tax a stock dividend is to tax a capital

increase, and not income, than this demonstra.

tion that in the nature of things it requires con.

NOTWITHSTANDING THE CONSTRUCTION PLAcepD

THEREON BY THE COMMISSIONER OF INTERNAL Rev-

ENUE, THE Income Tax Law or 1916 Dors Not

PurPort TO TAX THE ProceEeDs or THE SALE OF A

CapitaL INVESTMENT OR ANY PART THEREOF As

INCOME.

A tax levied on the entire net income as provided

in Section 1 (a) of the Act of 1916, would not apply to

any part of the sum received from the sale of an invest-

ment, because such sum in its entirety is a relization

of capital. If any income were included in such sum it

must have been equally included in the property before

it was sold. But it is not now open to argument that

capital increment is income in the absence of a sale.

Eisner v. Macomber, supra.

The Government, however, claims that the tax on

this increment is justified by Section 2 (a) of the Act

of 1916. This section levies no different tax, separate

from or in addition to the tax levied in Section 1 (a)

in value is capital increment, not taxable. That gain,

the capital increment, is not derived from the sale, and

does not come within the Act.

Unless a practical construction by the Treasury

Department can effectively enlarge the scope of a

statute imposing taxation, there is, in the Act in ques-

tion, at least a doubt which requires it to be “construed

Act should be held not to tax the realization of property

values, but only income.

CONCLUSION.

This case was argued at length, orally and by

exhaustive briefs on behalf of both parties, before the

—

——.. > —— ee

im

18

Judge of the District Court. who held the case under

advisement and after long and careful conmderation

filed a comprehensive opimon deciding the case on the

constitutional ground in favor of the plammtifl, (the

defendant in error here). Under these circumstances,

ordinarily, we would feel it due to this court to subma

a full discussion of cases cited. and other cases, and an

argument of greater length As certain questions m

the case have been presented to the court m other cases

recently, and in the brief thereon filed in behalf of the

plaintiff in error in the case of Goodrich v. Edwards,

No. 663, of this term. it seems unnecessary to burden

the court with detail which wou'd be, to some extent

at least, repetition of the substance of arguments pre-

sented in the Goodnch case

It is respectfully submitted that the judgment of

the District Court should be affirmed

Wussam D. Gurnee

Howey PF. Peeweces,

Gronee D. Watnovs,

Bagay Mowvun,

Ct Counsel for Defendant m Error

February, 1921