Petitioners Brief — Texas & Pacific R. Co. v. United States

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FILECOPY | ,.,.

IN THE

_— Court of the United Piates

OcTOBER TERM, 1931.

‘ No. 634.

THE TEXAS & PACIFIC RAILWAY COMPANY,

Petitiotier,

a | we

UNITED STATES.

BRIEF FOR PETITIONER ON WRIT OF

CERTIORARI TO THE COURT OF CLAIMS.

y

‘ JOHN W. DAVIS,

ADRIAN C. HUMPHREYS,

Newton K. Fox,

_ Attorneys for Petitioner.

INDEX.

. : PAGR ’

- OPINION OF THE CouRT BELOW .....,.......005- errr a |

JURISDICTION .....+-. fee cees ee eeeeees seecseseesspee Et

STATEMENT OF THE CASE .........% sittees humibews . 2

STATUTES INVOLVED ete Sa ac ote -

QUESTION INVOLVED ........ ene e eee e eee ee eens 3

"SPECIFICATION OF | rrr Sivdaveteaws Sulake ae

SUMMARY OF ARGUMENT ...... Pop aie ine red yo |

FS, Se. Pe vere ten ee or a

ET a ne >.

I, ‘THE “GUARANTY” PAYMENT UNDER THE TRANSPORTA-

« TION ACT, 1920, WAS A GOVERNMENT SUBSIDY DESIGNED TO

INSURE AN ADEQUATE TRANSPORTATION SYSTEM FOR THE

COUNTRY 2. .cscerscccccrevcns ee rs |

1. The situation of the railroads at the end of

Federal control and the purpose of the Transporta-

SF rrr ree eiaeaas feakites wine

en «x 2, There’ was no legal obligation on the Govern-

ment to.make the “guaranty” ..... ..ssceeseues 8°

ee

tm.

- U

3. The “guaranty” payment was not income from

operation of the railroads but was a subsidy ..:.... 9

. ‘ x. 4 * °

Il. BEING A suBSIDY, the “GUARANTY” PAYMENT IS NOT

“INCOME” WITHIN THE MEANING OF THE ‘SIXTEENTH

AMENDMENT eeeevweveoeveeeoeveeeeeeeveeeeeeee eee eeeeee eee eee & 11°

i

, PAGE

1. A subsidy is not taxable as “income”’..... aes 2E

2. Mutuality and consideration for the agreement.

to pay the “guaranty” “does not make the payment

taxable as “income” CREME EREEKMERTAGS CREOLE CES 12

‘3. The way in which the “gtaranty” payment

might be spent does not cotermine its status as

ge ee ee ee eee 14

4. Income Defined ite ecnie Len iescetents ae

QUI vcs oc dvnsdnvedes jiiate eee a

(APPENDIX: |

Excerpts from Revenue Act of 1918, Sections 218, 233.. 17 |

Excerpts from Transportation Act, 1920, Section 209.. 18.

df

iii

Table of Cases.

PAGE

Birmingham Trust & Savings Co. v. Atlanta, éte., Ry.

Clg BOW POR BFS is cdc crass cn csas Pets eonees rrr 4,9

Blodgett v. Holden, 275 U. 8.142 ..... cee geeceee eens 13, 16

Bowers v. Kerbaugh- -Empire Co., 271 U.S. 170 eer ere re 4,13

Eastern Extension, ete. Tel. Co. Ltd. v. United States,

ae 2 er eer Tre rr: eee ee eee ee 8

Edw ‘ards v. Cuba ‘Railroad Co., 268 U. 8S. 628.....4, 11:12, as

‘Kisner v. Macomber, 252 U. SS. reer ee ec 5, 18, 15, 16

Flint v. Stone Tracy Co., 220 U. 8S. 107...... Pere ye 9

Merchants’ Loan & Trust ic ‘Trustee v. Smietanka,

MR A a cei nae way ak ts kanss ieee pomee

Miles v, Safe Deposit Cos, 259 U.S. MR iN os 13

Smietanka v. First Trust & Savings Bank, 257 U. S. 602. 16

Stratton’s Independence Ltd. v. Howbert, 231 U. S.399. 9

United States v. Guaranty Trust Co., 280 U.S. 478. ..4, 6, 14

‘ United States v. Merri iam, 263 U. . errr . Be 13, 14

United States v. Supplee-Biddle Hardware Co., 265 U. 8.

are tee eeees hee ceu nee errr ween eee tenons 4,13

Statutes Cited.

7 .

Act of — of February 13, 1925.:.........08. Pa |

Corporation Excise Tax Act of August 5, 1909... inne ke 9

Federal Control Act ..,.. A Ase Rees Re EEN wf, 8, 5, 8

Revenue Act es eee rr re eee OY |

~ Rev entie Act of 1918, Sections 213.and 233 (Appendix). 17

Transportation Act, 1920 ........ 2, 3; 4, 5, 6, 8, 10, 13, 16, 18

Transportation Act, 1920, Section 209 (Appendix)... .18- 29

‘ . 3

Miscellaneous Citations.

Congrensianel Record, Vol. 58, Part Pere re 7,8

“Congressional Record, Vol. 58, |, ee ere 10, 11

Congressional Record, Vol. 59, Part 4..........+00095 7,10

Finance Docket No. 1176, 70 I. C. ©. 115........0 eee 8

—_—

iti

Bites. Aap eon

>

IN THB

- Supreme Court of the Huited States

OcToBER Term, 1931. a |

/

- |

No. 634. | es

, - ‘ . ’ mm

e . t. » 9 ; °

Tue Texas & Paciric Ramway Company,

Petitioner,

vs.

UNITED STATES,

r 3

“ >

* ~ ° .

“a

BRIEF FOR RETITION] ‘R ON WRIT OF

CERTIORARI yo THE COURT OF CLAIMS.

On writ of certiorari to the United States

to review a judgment in an action for the ref

income and excess profits taxes.

+

ourt of Claims

. Opinion of. the Court Below.

The opinion of the Coyrt of Claims is reported in 52 Fed.

- (2d) 1040 (Re13). j

Jurisdiction.

" The jurisdiction of the Court is invoked under Section

‘3(b) of the Act of Cong. February 13, 1925, e. 399, 43 Stat.

- 986, 939, amending Section 240 of the J udicial Code.

A petition for a writ of certiorari was filed on January

14, 1932 (R. 18) and was granted February 15, 1932 (R. 19).

og

2

Statement of the Case.

This is a suit to recover $208,138.01, part of the income

and excess profits taxes paid by Petitioner for the year 1920

under the provisions of the Revenue Act of 1918 (Act of

Cong. Feb. 24, 1919, c. 18), 40 Stat. 1057 (R. 8/.

Petitioner is a railroad eorpora and during the months

of January and February, 1920, sapsicconieos ‘were operated +

by the Director General of Railroads under the Federal

{ Control Act (Act of Cong. Mar. 21, 1918, c. 25), 40 Biat.

451 (R. 9). - -

Federal Control] terminated on February 29, 1920, under

the provisions of the Transportation Act, 1920 (Act of Cong.

Feb. 28, 1920, ‘c. 91), 41 Stat. 456, and, during the remainder

of the calendar year 1920, the Petitioner. was operated by a

receiver under a decree of court (R. 9).

Petitioner accepted the provisions of Section 209 of the

Transportation Act, 1920, and under the “guaranty” received —

for the period-of, six months after Federal-Control ceased,

called the “guaranty period”, the.sum of $2,043,041.77, and

one of its two subsidiaries receiVef $18,040.86, a total of

$2,061,082.63 (R. 9).

For the year 1920 Petitioner filed its tax return ang re-

ported thereon and paid a tax’ of $332,976.71 (R. 9). Peti-

tioner’s two subsidiaries filed separate tax returns’ and re-

ported losses (R. 10).

The Commissioner of Internal ‘Revenue upon audit and

_ reaudits of the 1920 returns in 1925, 1926 and, (1927, consoli-

dated the Petitioner and its subsidiaries (R. 10-11), made

paul s adjustments ‘to lincome and finally, in April 1927,

deter ined a consgHdated net income of $3,639,968.48 (R.

11), and a tax liability of Petitioner and its subsidiaries of

$363,796.85, which was allocated $361,797.42 to the Petitioner .

and $1,999.43 to one of its subsidiaries (R. 12). The result-

ing deficiency in tax of the Petitioner of $28,820.71 was duly ©

paid .(R. 12): The total net tax paid by Petitioner after

reimbursement made by the Director General of Railroads

was $349,737.51 (R. 12). :

ed

ee . . \

3 a »)

The Commissioner of Internal Revenue jf determining the __

consolidated net income of Petitioner and Ys subsidiaries for /

the year 1920 included as income the “guaranty” payment of

$2,061,082.63 made under Section 209(c) (1) of the Trans-

portation Act, 1920 (R. 12).

' Thereafter the Petitioner duly filed a claim for refund of

$206,108.26 based upon the erroneous inclusion in income of '

the “guaranty” payment and a claim for'$2,029. 75 based upon?

‘ certain minor items (R. 12).

The Commissioner of Inter nal antec rejected the veronammett

wee”

from the date of rejection (R. 3). ;

The Court of Claims gave judgment for the he Rie for

$1,962.09 (R. 13), sustaining thé Petitioner’s conténtions as

to the nffmor items. The Court held, however, that the “guar.

anty” payment of $2,061,082.63 was “income” ee to fax

(R. 15). ;

Statutes Involved.

my ‘ .

The Statutes involved are the Revenue pan of 1918 (Act xs

of Cong. February 24, 1919, ec. 18), 40 Stat. 1057, and Section

209(c) (1) of the Transportation Act, 1920 (Act of Cong.

¢ Feb, 28, 19: 20, c. 91), 41 Stat. 456, 464-467. Pertinent ex-

cerpts from these Acts are, i at in the Appendix hereto.

a Involved.

Was the “ramen payment under Section 209(c) (1) of

the Transportation-Act, 1920, a “subsidy” or taxable as “in-

come” under the Revenue Act of 1918 and the Sixteenth

‘Amendment to the Constitution?

Specification of Errors.

1. The Court of Claims erred in holding that the “guar-

anty” payment to Petitioner under Section 209 of the-Trans-~

portation Act, 1920, was “income” taxable under the Revenue

“a 1918 and the Sixteenth Amendment to'the Constitution.

ie

3 ge se .

‘4 ' r x Fi

¢

ie

~ the Court of Claims erred in not ent

Petitioner in the sum rf SV) 200.07, the

overpaid for 1920 on excluding the “guaranty pavinent f

“income”

Summary of Argument.

I. The condition of the railroads at the termination of

Mederal contvol was such that rehabilitation was necessary

to insur@ ah adequate transportation system, The purpose

of the Transportation Act, 1920, was to remedy this situation

United States Vv. Guaranty Trust Co., 280 U.S. 478.

Congress recognized the immediate need of the railroads

for additiongk“eapital”’. Without any legal obligation on the

part of the Government, the Transportation Act Was massed

providing fe

The “gué

of the railrgad. Birminghom Trust & Savings Co. v. Atlanta

etc. Ry. Co. a0@Age. 173. The payment was in fact and

was intended by Congress as a subsidy. ’

‘a “guaranty” payment,

‘anty” pagment was not income from operation

Il. Being a Mifsidy the “guaranty” payment is not income

Within the meaning of the Sixteenth Amendment. Edwards

Vv. Cuba Railroad Co,, 268 U.S. 628. Every economic ad-

vantage or rec@pt of money does not result in “income”,

Mutuality and @6nsideration did not remove the “guaranty”

payment from the category of a subsidy or convert it into

“income”, Ldwards \. Cuba Railroad Co., supra; ¢ nited

States v. Supplee-Biddle Hardware Co., 265 U. 8. 189;

Bowers V. Kerbaugh-Empire Co., 271 U. S. 170. The provi-

sion for payment by the railroads to the Government of any

excess over the “guaranty” was a limitation or condition to

eliminate carriers not in need of the subsidy. It was not

inserted as a money producing provision for the Government.

‘It was designed primarily as an administrative measure to

eliminate applications by carriers not in need of financial

assistance and to save auditing expenses and delay.

et ire e “gua anty” parment, and not the fhanner

vhich it might be spent, determines qhether it is “income”

Merriam, 203 6 8. 159. The “guaranty”

yt was fot derived from capital er labor, or from both

nbined It was not “income” within the definition which

this Court has ndopted and consistently followed, HLisner vy.

acomle o2 tS IS, a8 a limitation upon the power of

lnder tha Sixteenth Amendment.

ARGUMENT.

Preliminary Statement.

The question of the taxability as “income” of the payment

under Section 2O9(e)(1) of the Transportation Act, 1920,

is not to be confused with payments made to carriers under

the Federal Control Act as compensation for the use by the

Government of railroad properties during Federal Control.

The Transportation Act terminated Federal Control on Feb-

ruary 29, 1929.

Payments under the Federal Control Act are admittedly

“income” and subject to tax. Taxes based on those payments

and on earnings of Petitioner from operation of its road in

1920 are not sought to be recovered in this action,

This case involves a “guaranty” payment under the Trans-

portation Act, 1920, for the period of six months, March 1,

1920, to August 31, 1920, called “the guaranty period”, after

possession and use by the Government had ended and the

properties had been returned to private ownership,

Section 209 provides for a “guaranty” payment by the Gov-

ernment under various conditions prescribed therein. This

case, falls under Section 209(¢)(1) as the Petitioner had a

contract fixing just compensation for the Federal Control

period. TR. this case the amount of the ‘ ‘guaranty’ payment

is the excess of one-half of the annual amount fixed as “just

compensation” in the Federal Control contract over “railway

operating income.” '

“Railway operating income” (a term defined by the Inter

state Commerce Commission in its Regulations, “Issue of

1914", governing the “Classifcation of Income, Préfit and

_Loss for Steam Roads”) is an amonnt determined by deduct

ing from “railway operating revgfiues”, the items of “railway

operating expenses”, “railway tax accruals”, and “uncotlecti

ble railway revenues.”.-*—

”

a

“”

Pa

I.

The “Guaranty” Payment Under the Trans-

portation Act, 1920, Was a Government

Subsidy Designed to Insure An Adequate

Transportation System for the Country.

1. The situation of the railroads at the end of Federal con-

trol and the purpose of the Transportation Act, 1920.

Government operation of railroads during the war years

had resulted in a critical situation and the maintenance of a

transportation system for the United States was at. stake,

Tracks, structures and rolling stock Jad deteriorated. . Addi-

tions and betterments were imperative. Funds were needed

for improvements, expansion and additional equipment. The

railroads had to be rehabilitated from the standpoint of “cap-

ital.”

The condition of the railroads when the Transportation

Act, 1920,. was passed and the purpose to preserve for the

nation the whole existing transportation system was stated

by this Court in / nited Ntates v. Guaranty Trust Co., 280

U.S. 478, as follows:

“These appropriations were made in order to meet a

pressing need, At the time of the passage of Transporta

tion Act, 1920, most of the railroads of the United States

lacked funds for necessary improvements, equipment,

and expansion of facilities. Some of the carriers needed

funds, also, to meet maturing obligations. The credit of

7

many carriers was seridusly impaired. There was a gen-

eral reluctance among investors to purchase new rail-

road securities even of the strongest railroads, Con-

gress deemed it important to preserve for the nation sub-

stantially the whole existing transportation system.

Compare New England Divisions Case, 261 U. 8. 184,

190". (p. 484). ’

The same purpose Was expressed by Congress.

Senator Cummins, Chairman of the Interstate Cominerce

Committee of the Senate, said (Ceng.-Ree., Vol. 59, Part 4,

p. 3327) : .

“Without entering into the details of the situation it

is well known to every observer that .we need from

100,000 to 200,000 additional cars, we need more main

tracks, more side tracks, more warehouses, and more

terminal faeilities of all kinds. If the railways are to

succeed in giving to the people what they must have, if

we arato prosper, these companies must borrow or secure

in some way not less than $600,000,000 this vear and

$1,000,000,000 next year.”

Representative Cooper, a member of the Interstate Commerce

Committee of the House, said (Cong. Ree., Vol. 59, Part 4,

p. 83808) : “

'

“es * * “It is estimated that about 200,000 new cars

must be built in 1920 to make good the deficiency.

It is also stated that the nofmal railroad require-

ments are about 3,000 new locomotives per year, yet dur-

ing Federal control only 2,000 locomotives, or one-third |

of the normal requirement has been provided. Only 923

hew passenger cars have heen pfirchased in over two

years and only 721 miles of raalroad extension have been

built.” .

Representative Barkley, a member of the Interstate Com-

merece Committee of the House, said (Cong. Ree., Vol. 58,

Part &, p. S445): .

“Therefore as a matter of fact if we do not help them

to finance at this time these capital investments they

8

will have to go into the markets at the present high mur

of money and finance them themselves, And the inal

itv te do so is yoing’to put many of the railroads int

the hands of receivers.”

$

Regpesentative Karkley (Coyg. Ree, Vol. 5s, Pyrt x b

S331) : <

“T think it is not going too far to Sis that if we on

the 3ilst of December were to turn the roads back to

their owners without remedial legislation, it would re

sult in the most disastrous financial panic that the

country has ever seen.”

2. There was no legal obligation on the Government to

make the “guaranty”.

The “guaranty” payment to Petitioner did not arise from

any legal obligation on the part of the Government.

See: Finance Docket No, 1176, 701. C. C. 115, 116.

Compares: Eastern Extension, etc. Tel. Co. Ltd. v. United

States, 251 U.S. 355, 363-364.

The Federal Control Act provided for the settlement of all

mutters growing out of the Fedeyal control period. The

Transportaign Act did not apply to that period or to settle

ments based on use of the properties by the Government dur

ing Federal Control, )

Furthermore, it should be noted that Section 209, by Sub

division (c) (4), makes the Act equally apflicable to carriers

that had not been under Federal control.

The Court of Claims in its opinion admits that there was

“no legal obligation in enacting this legislation requiring the

Government to make these payments,” but says “that there

were obligations of ‘an equitgble, moral, and honorary

nature’ which “may well be said to take the place of a legal

obligation.”

”

3. The “guaranty” payment was not income from opens

tion of the railroads but was a subsidy

The “guaranty” pavment was not derive from services

rendered or to be rendered by the Petitioner to the L nite

States. It Was not compensation for use of the railroad prop

erties by the Government which endet March | igo sit

Wis nota prqut or gain derived from the use or operation of

the rarlroad by the Petitioner

“The eMaranty Mneney Was not produced hy railroad

operation.”

Birmingham Trust and Savings Co. itlanta, ef

‘

Ry. Co., 300 Ped 173, 179

Petitioner's earnings from operation of ite railroad in 1920

have been included in taxable income and the tax paid there

on is not cyntested in this suit

While “railway operating tmeome” on the one hand, and

one-half of the annual amount of “just compensation” speci

fied in the Federel Control contract on the other hand, are

_ used in this case as the basis for compoting the amount of

the “guaranty” payment, the stibsidy itself is the result of

comparing (se f factors,

The “guaranty” payment ® neither “railway operating in

come” nor “just compensation’ as those terms are used only

as a mesure to determine, first, qualification for receiving

the subsidy, and, seeond, the amount of the subsidy. Used as

a yardstick or measure they do not characterize the “guar

anty” payment as either “operating income” or “jist com

pensation’. The terms are used in the same « apacity as

“income” was used as a measure for the C Orpen ation Excise

Tax levied by the Act of August 5, 1909, «& 6, 36 Stat. 113

Although income was there used as the measure, this Court

held that the Act levied an “Excise” and not an “income”

tax. a

Flint v. Stone Tracy Co., 220 U. 8. 107:

Ntratton’s Inde pe nlence Ltd. v. Howhert, 221 U &

399

7]

While sevtion 20/4) provides that any excess of “railway

operating ieeme over eGe half the amount named in the

Pateral Contrel comtract must te paid into the Treasury

there Was Go cicewe in this case .

To sey thet “operating income” was guaranterd is not only

eTrumemas bat lege the question of the fundamental nature

of the payment Was it “income” or a “wubegdy”” as intended

he ( om grene *

The particular language used in section 200 of the Trans

pertation Act, 1920. is of importance = It states “The Unite

Mtates herely guarantees’, it provides a “guaranty” and re.

fers te “the guaranty peri”

Payments auder Section 200 of the Transportation Act,

1920 were referret to by memlers of Congress as a “suleidy”

or “gift

As typleal we quote Representative Kitchen (Cong Rew.

Vel 39, Port 4, p. 3313)

“In my judgment. end | make the prediction that it

Will require practically the entire amount of the stand

ard return for the «it months, that is, $475,000,000. to

make gow! the guaranty

Whater he amount shall be, it is an absolute gift In

the Chower t to the railroads the deliberate taking

out of thy’ pockets of the taxparere and giving it to the

railroad .

Representative Sime, a member of the Interstate Commerce

Committee of the Howse (Cong Ree. Vol 59. Part 4. iu

3289 )

“Bat set eatiefied with thie barden upon the people,

we give a eabetly for the first six months”

Represetitative Steagall (Cong Ree, Vol. S58, Part 9, p

S675)

“They (the people) are going to te sorely disap

pointed when they learn that this bill looks to an in

erease of these bardens along With its enormous subs)

to the roads ”

11

Representative Box (ong. Ree., Vol. 58, Part 9. p. BIRD):

Phe amount which this will cost the Gioveriment, in

guaranties and subsidies, will run into hundreds of mil

ons, while h. in midition to the suits loaned to the roads,

will be taken from the public treasury at a tifne when

the Government is already paving out from one to four

billion dollars more per year than it is receiving in taxes

and revenues, and will greatly inerease the already

heavy deficita,”’

lhe yruarunty peryvinent was not received for services

lore to the United States. The payment was not derived

capital It was a Goyernment m1 Gail s or aid, so in

dethy Congress, with Me view of protecting and insuring

mMeoent system of transportation for the people,

II.

|

Being a Subsidy, the “Guaranty” Payment Is

Not ‘Income’ Within the Meaning of the

Sixteenth Amendment.

|. A Subsidy Is Not Taxable as “Income”,

controlled by the decision of this (‘ourt in

(uha PR Ce “in | Ss. 6S, holding that sub

it 7 oid by the Cuban Government were not

e under the Sixteenth Amendment to the

‘ pityst | ft cuse the Cuban Gov rnment granted

Ni lersev railroad corporation based on the

matructed Te receive the subsidies

? had to os mply with certain definite

esecuted contracts the company agreed

net i raluetion in rates for Transportation of em

‘ iy pe of the G vernimept, to reduce first class

.

w yy? COrresys ndefnice free. to eurry stall

lice { e half the tariff, to allow the frovernment to

Sa

(<— 68 see ete . es. —-— —- a ~

—_—

ee ee ee ee

establish telegraph and telephotle stations along the railroad

and to transport troops in special trains at special rates in

case of war,

Under these circumstances, this Court said:

® @ @ «se?

legislation and arrangements for the promotton of rail

road construction which have been well known in the

United States for more than half a century. Such aids,

gifts and grants from the government, subordinate polit

ical subdivisions or private sources, whether of land,

other property, credit’ or money,—-in order to induce

construction and operation of railroads for the service

of the pub lic are not given as mere gratuities, Burke y

Southern Pacific R. R. Co., 234 U.S. 669, G79: Louis

ville & Nashville R. R. vy. United States, 267 U4 8. 395.

Usually they are given to progote settlement and to

provide for the development of the resources in the ter

ritory to be served. The things so sought to be attained

in the public interest are numerous and varied. * * *

The subsidy payments were proportionate to mileage

completed ; and this indicates a purpose to reimburse

plaintiff for capital expenditures. * * * The subsidy

payments taxed were not made for services rendered or

to be rendered, They were not profits or gains from the —

use or operation of the railroad, and do not constitute

income within the meaning of the Sixteenth Amendment

See Stratton’s Independence Vv. rer rt, 231 U. 8. 399,

415; Eisner v. Macomber, 252 U.S. 189, 207: Merchant«’

Loan & Trust Co, v. Smietanka, supra. * (pp. 632-683),

2. Mutuality and consideration for the agreement to pay

the “guaranty” does not make the payment taxable as “in.

come”.

In this respect the instant case is even stronger than the

Cuba Railroad Case (supra). In the Cuba Case the com

pany agreed, by executed contracts, to reduce existing rates

one-third for carrying Government troops and employees, to

carry Government mails free, to reduce rates for first-class

passengers, to carry small produce for one-half the tariff,

to allow fhe Government to establish telegraph and tele

rhe Cuban laws and contracts are similar to

Ps le

phone stations along the railroad and in case of war t&

transport troops in special trains at special rates

All these were conditions attache! to mx eiving the sab

sidy and were consideretions for “a payment There wae

real consideration and mutuality of obligation. Evea aoder

these conditions this Court held that the considerations aed

the mutual and contractual obligations of the railroad aed

the Government did noyvtender the payments “iaeeme

consideration as such does not nec vunt

received under the contract “income” within the definition

Kvers valid contract mast rest upon NerTegeNa bat

dari make the ak

of this Court, Consideration for a efntract eanneot alone

‘create “income”, Every economic advantage or receipt of

money does not result in “income”. This Court has so held

in the case of proceeds of insurance on thellife of an office:

(l nited Ntatesx vy, Supplee Riddle Havrdu ane f‘o.. 265 #8

IS), the extinguishment of a debt for leww* than jut face

(Bowers Vv. NerbaughEmpire Co, 271 UB LTO). and a

subsidy payment (Cuba Railroad Case, supra) ta thom

cases the anounts were received under contracts baeed upon

real consideration and mutuality of obligation

Also the receipt of a stock dividend (Liawer ¥ Macomber

2o2 US. ISO), and a stock right (Miled vy. Sat De poait ¢

oO US. 247), were held not to be “income”. Purtherwor

a bequest to an executor in lieu of compensation Cl sited

States Vv. Merriam, 263 U.S. 179), and a gift (Blodeert

Hold n, 275 U. 8. 142), have been held not to be taxable

“income”, ‘

Thar the petitioner assented to the provisions of the Trane

portation Act and agreed, on the regiote condition of excess <o

earnings, to pury stn h excess to the Governme nt cannot aiter

or affect the question of whether the subsidy paid was, i

fact, “income”,

The purpose of Section 209 was to give Governmental abd

to those carriers which needed rehabilitat@@n, and thas ©

insure transportation facilities to the country at large Buch

aid to be effective would haye to be prompt With this pews

14:=«C- Si ee "

pose in veel it was necessary to exclude carriers which were

_ not in need of aid. ‘The provision that a‘qualifying carrier

realizing an excess during the g guaranty period must pay such |

excess into the Treasury was a limitation or condition that

effectively eliminated from the subsidy carriers which did

‘not @eed it. ,The conditioh likewise relieved the Interstate

Commerce Commission of an enormous auditing and expense

‘burden.

condition limiting payment to only those carriers in need,

It wouldse absurd to consider the condition as a money

producing provision. It was.recognized from the outset that

the Government would receive little or nothing under the

provision, but on the other hand would be compelled to pay

the or. . ae

3. The way in which the “suaranty” payment might be

spent does not determine its status as “income”.

The nature or character of tlie “guaranty” payment. cannot

be determined from its use. Taxability as “income” does

not depend upon how the money veceived is spent, whether

for capital additions, current expenses or what not. .If in its

nature the “guaranty” i is not “income” within the definition

of this Court, the use to. which it is - cannpt ae A it

into “inecome’”’. .

Compare: United States v. Merriam, 263 U.’S. 179.

While there was no restriction on how the “guaranty” pay-

ment was spent, the railroads urgently’ needed “capital” ‘for

cars, tracks, terminal | facilities, buildings, capital improve-

ments; additions and betterments and the pgm of. the,

Act was to meet that need.

United States v. Guireniy § Frust Co. onpilt p. 6);

Staiement of Senator Cummins (supra, p. 7) ;

Statement of Representative Cooper (supra, p. 7).

<

See:

+. r al

. %

The provision as to excess earnings Was really a,

s .

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.

. 15

4. Income Defined.

This Court in the de of Lisner v. Macomber, 252°U. &.

189, defined “income”,-within the meaning of the Sixteenth

Amendment to the Constitution, as follows:

“«~ * * “‘Tncome may be defined as the gain derived

from capital, from Jabor, or from both combined,’ pro-

vided it be understood to include profit gained through

a sale or conversion of capital assets, to ‘which it was

applied in the Doyle Case (pp. 183, 185).”

7" Oe & * 6“The Government, although basing “its argu-

ment upon the definition as quoted, pla wed chief emphasis

upon the word ‘ gain,’ which was extended to ‘nclude a

variety of meanings; while tN significance of the next

three words: was either overlooked or misconeeived.

# ‘Derived-from-capital’ ;—the gain-derived-frome-capital.

; } , 9g f /

ete.” (p. 207). ‘

In the case of Merchants’ Loan & Trust Co., Trustee v.

a Smietanka, 255 U. S. 509, the above definition was followed

(pp. 517-518) without modification or change, “this Court

being “entifely satisfied” with the completeness of the deti-

nition.

’ The definitiorg of income in the Macomber Casetwas not

caguM or used by way of illustration. It-represents av all.

ipelusive rule est» blished for future use in determining what

‘is “income”. The Court after defining income then consid-

ered whethei a stock dividend fell within its terms. This

established defimition has been consistently used in deciding

all- subsequent cases invelving the question of what is

“income”. -

As to the constitutional limitation upon Congress and the

” distinction between what is and what is not “income” this

Court said in the Macontber Case, at page 206:

“In order, therefore, that the clauses cited from

- Article I of the Constitution may have proper force and

effect, save only as modified by the Amendment, and that

the latter also may have proper effect, , it becomes. essen-

4

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ee ed a

a ee * <

were

.

eee ae

RPS ste sscee PRM Ese

16

tial to distinguish between what is and what is not ‘in

come’, as the term is there used; and to apply the dis

tinction, as cases arise, according to truth and sib.

stance, without regard to form. Congress cannot by any

definitién it may adopt conclude the matter, since it cay

not. by legislation alter the Constitution, from which

alone it derives its power to legislate, and within who

limitations alone that power can be lawfully exercise: .

The constitutional limitation upon the power of Congiwss

to levy taxes must be strictly complied with.

Fisner v. Macomber, 252 U. S. 189, 206, 211:

Smietanka vy. First Trust & Savings Bank, 257 U.S.

602, 605-606 ;

Blodgett v. Holden, 275 U.S. 142, 148.

Congress, under the Sixteenth Amendment, has only the

power to tax “income” in fact. If no income is in fact re

ceived there is,no basis for the tax.

The “guaranty” payment under Section 209 of the Trans:

-portation Act, 1920, was not “derived” from “capital or

labor” nor from ‘a sale or conversion of capital assets.” It

was not “income” under the definition of this Court.

CONCLUSION.

The “guaranty” payment lacks every characteristic neces:

sary to constitute “income” as this Court has defined that

term. The Court of Claims was in error in holding that the

payment was “income” subject to taxation.

-The judgment below should be modified accordingly.

Respectfully submitted,

; pres JOHN W. Davis,

ADRIAN C. HUMPHREYS,

can NewrTon K. Fox,’

Attorneys for Petitioner.

APPENDIX.

Revenue Act of 1918,

(40 Stat. 1057)

SECTION 213. (40 Stat. 1062.)

“See. 215, That for the purposes of this title (except as

otherwise provided in section 233) the term ‘gross Income’

(a) Includes gains, profits, and income derived from

salaries, Wages, or Compensation for personal service (includ

ing in the case of the President of the United States, the

judges of the Supreme and inferier courts of the Lnited

States, and all other officers and emplovees, whether elected

ov appointed, of the United States, Alaska, Hawaii. or any

political subdivision thereof, or the District of Columbia.

the compensation received as such), of whatever kind and in

whatever form paid, or from professions, vocations, trades.

businesses, commerce, or sales, or dealings in property,

Whether ‘real or personal, growing out of the ownership or

use of or interest in such property; also from interest. rent.

dividends, securities, or the transaction of any business car

ried on for gain or profit, or gains or profits and income de

rived from any source whatever. The amount of all such

items shail be included in the gross income for the taxable

year in which received by the taxpayer, unless, under

methods of accounting permitted under subdivision (bh)

“of section 212, any such amounts are to be properly ae

counted for as of a different period; but

(b) Does not include the following items, which shal] be

exempt from taxation under this title:

* . * * * * *

(3) The value of property acquired by gift, hequest, de

vise, or descent (but the income from such property shall be

*

.

included in gross income) :

SECTION 233. (40 Stat. 1077.)

“Src, 233. (a) That in the case of a corporation subject to

thetax imposed by section 230 the term ‘gross income’ means

the gross income as defined in section 213% * *” with cer-

tain enumerated exceptions which are here immaterial.

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18

Transportation Act of 1920.

SECTION LOO, (AL Stat, 456, 464-467.)

CGGUARANTY TO Carnkiers APTER TERMINATION O}

bP eDERKAL CONTROL,

“sec, YOO (a) When used in this seetion

The term ‘carrier means (1) a carrier by railroad or partly

by railroad aud partly by water, whose railroad or system

Of transportation is under Pederal control at the time Ped

eral control terminates, or which has heretofore engaged as

a common carrier in general transportation and competed

for trate, or connected, with a retlroad at any time under

Federal control; and (2) a sleeping car company whose

SVstern of transportation is under Federal control at the time

Federal control tertninates: but does not incejude a street or

interurban eleetric railway not under Federat control at

the time Pederal control terminates, which has as its prin-

cipal source of operating revenue urban, suburban, or inter

urhan passenger traflic or sale of power, heat, and light, or

both

The term ‘guaranty perjod’ means the six months begin-

los March 1, 1920. ,

The term ‘test period’ means the three years ending June

30, 1917; and

“

The term ‘railway operating income’ and other references

to accounts of carriers by railroad shall, in the case of a

sleeping car company, be construed as indicating the appro-

priate corresponding accounts in the accounting system pre-

scribed by the Commission. .

(b) This section shall not be applicable to any carrier

whith does not on or before March 15, 1920, file with the

Commission a written statement that it accepts all the provi-

sions of this section.

(c) The United States hereby guarantees

(1) With respect to any carrier with which a contract

(exclusive of so-called cooperative contracts or waivers) has

been made fixing the amount of just compensafion under the

Federal Control Act, that the railway operating income of

19

such carrier for the guaranty period as a whole shall not be

less than one-half the amount named in such contract. as

innual compensation, or, where the contract fixed a lump

sum as Compensation for the whole period of Federal opera:

tion, that the railway operating income of such carrier for

the guaranty period as a whole shall not be less than an

unmount Which shall bear the same proportion to the lump

sum so fixed as six months bears to the number of months

during which such carrier was under Federal] operation, in.

cluding in both cases the increases in such compensation

provided for in seetion 4 of the Federal Control Act:

(2) With respect to any earrier entitled to just compen-

sation under the Federal Control Act, with which such a

contract has not been made, that the railway operating in-

come of such carrier for the guaranty period as a whole shall

not Be less than one-half of the annual amount estimated by

the President as just compensation for such carrier under the

Pederal Control Act, including the increases in such com-

pensation provided for in section 4 of the Federal Control

Act. If any such carrier does not accept the President's esti-

mate respecting its just compensation, and if in proceedings

under section 3 of the Federal Control Act it is determined

that a larger or smaller annual amount is due as just com-

pensation, the guaranty under this paragraph shall be in-

creased ov decreased accordingly ;

(3) With respect to any carrier, whether or not etititled

to just compensation under the Federal Control Act, with

Which such a contract has not been made, and for which no

estimate of just compensation is made by the President, and

Which for the test period as a whole sustained a deficit in

railway operating income, the guaranty shall be a sum equal

to (a) the amount by whieh any deficit in its railway operat:

ing income for the guaranty period as a whole exceeds one-

half of its average annual deficit in railway operating income

for the test period, plus (b) an amount equal to.one-half the

annual sum fixed by the President under section 4 of the

Federal Control Act: :

(4) With respect to any carrier not entitled to just com-

pensation under the Federal Control Act. whieh for the tesf

period as a whole had an average annual railway operating

income, that the railway operating income of such carrier for

the guaranty period as a whole shall not be less than one-half

arenes.

2

~

a

ee ee

.

meet

20

the average annual re-lway operating meome of such carrier

during the test period ’

(dd) If for the guarahty perigd as nh whole the railway

Operating Theome of any cart ier entitled tooa guaranty wns

paragraph ¢la, (2) or (4) of subdivision (e) is in excess

of the minimum railway operating income guaranteed in such

paragraph, such earrier shall forthwith pay the amount of

such excess into the Treasury of the United States. If for

the guaranty period asa whole the railway operating income

of any carrier entitled to a quaranty under paragraph (3)

of subdivision (¢) is in exeess of one-half of the annual sium*

fixed by the President with respect to such earrier wider

section 4 of the Federal Control Act, sueh carrier shall forth

With pay the amount of such excess into the Treasury of the

United States. The amounts so paid into the Treasury of

the United States shall be added to the funds made available

under section 202 for the purposes indicated in such section.

Notwithstanding the pr ‘isions of this subdivision, any car:

rier may retain out of any such excess any amount necessary

to enable it to pay its fixed charges accruing during the guar:

anty period,

(e) For the purposes of this section railway operating in-

come, or any deficit therein, for the test period shall he com-

puted in the manner provided for in section 1 of the I ‘ederal

Control Act.

(f) In computing railway operating income, or any deficit

therein, for the guaranty period for the purposes of this

section—

(1) Debits and credits arising from the Accounts, called in

the monthly reportly to the Commission equipment rents and

joint facility rents, shall be included, but debits and credits

arising from the operation of such street electric passenger

railways, including railways commonly called interurbans, as

are not under F ederal control at the time of termination

thereof, shall be excluded ; ’

(2) Proper adjustments shall be made (a) in case any

lines which were, during any portion of the period of Federal

control, a part of the railroad or system of transportation of

the carrier, and whose railway operating income was included

in such income of the carrier for the test period, co not con-,

tinue to be a part of such railroad or system of transporta-

" ix] i al

ny ines aequ red by Caused te ih Lite W

I road or svstem of t1 lnsportation I thie i ‘ Lanyt

since the end of the test perl d nd pri I Lhe eX]

of the guarunts je hat, fo vhich ad | © UR | x ret

to the Commission are not a Ii re pect lo the ¢

tion of the guaranty period ;

(3) There shall not be inelnded in operating expenses

maintenance of Wav and structures r to hits t

equipment, more than an amount fixed hy the ¢

In tixing such amount the Commission sha “> Tar As

ticable apply the rule set forth in the Proviso |

(a) of section oO of the “standard contract bet w ee

United States and the carriers (whether or not such eont

has heey entered into with the carrier whose 1 i Vail

uting mcome is being computed | :

(4) There shall not be included any taxes paid under

lor Il of the Revenue Act of LOLT. or sneh portion of

taxes paid under Title Il or ITT of the Revenue Aet of |

us Hy the terms of sueh Act are to be treated as ley md

Act in amendment of Title Lor Il of the Revenne Act

1917; and

(oO) The Commission shall require the elimination and

statement of the operating expenses and revenues (other th

for maintenance of way and structures, or maintenance

equipment) for the guaranty period, to the extent necessay

to correct and exclude any disproportionate or unreasonall

charge to such expenses or revenues for such period, or any

charge to sugh expenses or revenues for such period whieh

under proper svstem of accounting is attributable te an

other. period.

“ The Commission shall. as soon as practicable after Certifi

the exptration of the guaranty period, ascertain and certify rab.

to the Secretary of the Treasury the several amounts neces: make

sary to make good the foregoing guaranty to each carrier, 2"

The Secretary of the Treasury is hereby authorized and di

rected thereupon to draw warrants in, favor of each such

carrier upon the Treasury of the United States, for the

amount shown in such certificate as necessary to make good

such guaranty, An amount sufficient to pav such warrants

is hereby appropriated out of any money in the Treasury not

otherwise appropriated,

Appr