Before CLARK, HINCKS and HARLAN, Circuit Judges.
The question raised by this petition is the extent to which the fair market value of a corporate distribution in kind is taxable to the shareholder-distributees as ordinary dividend income where the earnings and profits of the distributing corporation are sufficient to cover the adjusted cost of the property distributed but are insufficient to cover its full fair market value at the time of the distribution.
In 1947, Southern Natural Gas Company (hereinafter called "Southern") distributed as dividends to its shareholders (of whom Respondent was one) $2,113,722.03 in cash and 1,409,162 shares of common stock of Southern Production Company, Inc. (hereinafter called "Southern Production"), a wholly owned subsidiary of Southern. The Southern Production stock had an adjusted cost value on Southern's books of $3,199,950. Its fair market value at the time of distribution was $8,983,407.75. Southern had earnings or profits before these distributions amounting to $5,674,586.32. The respondent taxpayer's proportion of these distributions amounted to $12,680.62, of which $2,416.87 represented its share of the cash distribution and $10,263.75 its share of the distribution payable in Southern Production stock, taken at market value.
In reporting these distributions in its federal income tax return for 1947, the taxpayer proceeded on the premise that the market value of the Southern Production stock was taxable to Southern's shareholders as dividend income only to the extent of Southern's earnings and profits, determined without regard to any appreciation in the value of Southern Production stock above its adjusted cost basis on Southern's books. The Commissioner, however, ruled that the Southern Production stock was taxable to Southern's shareholders as ordinary income to the full extent of its fair market value at the time of receipt, and accordingly determined that the taxpayer had understated its income for 1947. The Tax Court sustained the taxpayer's position, holding that the market value of Southern Production stock in excess of Southern's earnings and profits, as computed on the basis of its adjusted cost on Southern's books, was applicable first to reduce the basis of the shareholders' Southern stock and beyond that was taxable as a capital gain as provided in § 115(d).
The controlling sections of the Internal Revenue Code are § 22(a) and (e), 26 U.S.C. § 22, and § 115(a), (b), (d) and (j), 26 U.S.C. § 115. Their relevant portions are printed in the margin.*fn1
The taxpayer's position is that the provisions of § 115(a), defining a dividend as any distribution made by a corporation "out of its earnings or profits accumulated after February 28, 1913," also measure the extent to which a distribution in kind is subject to dividend taxation in the hands of the shareholders, that is that the market value of the property distributed is not taxable as "dividend" income beyond the extent of the corporation's "earnings or profits," any excess value being subject to a different kind of tax treatment as held by the Tax Court.
More specifically, the taxpayer contends that after eliminating from Southern's "earnings or profits" the cash dividends of $2,113,722.03, which are concededly taxable to Southern's shareholders as ordinary income to their full extent, the value of the Southern Production stock ($8,983,407.75) is taxable as a dividend only to the extent of Southern's remaining "earnings and profits," viz ., $3,560,864.29. The remaining value of the Southern Production stock, $5,422,543.46, it is contended, is subject to the other tax treatment indicated above.
The Commissioner's position is that all that is excluded from individual income taxation under § 115 are distributions to shareholders which impair the capital of the distributing corporation. In essence his argument is that we should distinguish between the value of an asset in the hands of the corporation for the purpose of determining surplus or capital impairment, and the value of the asset for tax purposes when distributed to the shareholders. In the first aspect, so the Commissioner argues, the value of the asset is its historical cost to the corporation, without regard to any subsequent appreciation in value; in the second aspect, the worth of the asset is its full market value at the time of receipt by the shareholders; and under the statute there is no necessary money correlation between these two sets of values. Therefore, it is contended, once it is shown that a distribution in kind has left the corporate capital intact, the distribution is "out of" the corporation's "earnings or profits," and hence a dividend under § 115(a), which under § 115(j) becomes taxable to the shareholders to the full extent of its market value at the time of receipt.
More specifically, the Commissioner contends that Southern's earned surplus ($5,674,586.32) being greater than the total value ($5,313,672.03) of the distributed cash and Southern Production stock (at its adjusted cost to Southern), the entire distribution constituted a dividend, and as such the part represented by Southern Production stock, equally with the cash part, was taxable as ordinary income to the full extent of its fair market value, viz ., $8,983,407.75.
We are thus called upon to decide between these two opposing views of the taxing pattern established by § 115. The decisions of the Tax Court have fairly consistently supported the taxpayer's position. Estate of Godley v. Commissioner, 1953, 19 T.C. 1082, relating to the identical distributions here involved, and upon which the decision below was based; Dean v. Commissioner, 1947, 9 T.C. 256; Estate of Acheson, 1944, 3 T.C.M. 1242; and in its result Beach Petroleum Corp. v. Com'r, 1946, 5 T.C.M. 638.
The cases in the Federal Courts, however, do not give us any clear signal. In Binzel v. Commissioner, 2 Cir., 75 F.2d 989, certiorari denied 1935, 296 U.S. 579, 56 S. Ct. 90, 80 L. Ed. 409, relied on by the Commissioner, it did not appear whether there was sufficient surplus to cover the full market value of the distribution in kind. If there was, then that case did not reach the issue before us. If there was not, we would hesitate to accept the alternative basis for decision, namely, that the distributed property was acquired out of post-1913 earnings or profits and retained that character upon distribution. See Paul, Selected Studies in Federal Taxation, 2d Series (1938), pp. 174-176; Molloy, Some Tax Aspects of Corporate Distributions in Kind, 6 Tax L.Rev. 57, 74-76 (1950). For the same reason we find Commissioner of Internal Revenue v. Wakefield, 6 Cir., 1943, 139 F.2d 280, also cited by the Commissioner, not persuasive. The concurring opinion of Judge Whitaker in Guinness v. United States, 1947, 73 F.Supp. 119, 109 Ct.Cl. 84 is an acceptance of the Commissioner's position, but the decision of the majority went upon other grounds, based on facts not involved here. In Commissioner v. Timken, 6 Cir., 1944, 141 F.2d 625, cited by the taxpayer, a dividend in kind was held not taxable as income to the stockholder, but there the cost of the property distributed was not covered by any earnings or profits (which had been exhausted by prior cash dividend distributions), and in effect constituted a distribution of capital .
We also consider the legislative history of § 115, which has been referred to in the Respondent's brief, wholly unclear. Finally, we find tax lawyers, who have written on the subject, on both sides of the question. See Paul, Selected Studies, etc., supra, 165-185, and Raum, Dividends in Kind: Their Tax Aspects, 63 Harv.L.Rev. 593-609 (1950).
We turn then to examine the provisions of the Internal Revenue Code themselves. Section 22(a) defines "gross income" to include "dividends * * * or gains or profits and income derived from any source whatever." No contention is made here that the Southern Production stock constituted "income" to Southern's shareholders otherwise than as a "dividend." Section 22(e) provides that corporate distributions are taxable to the shareholders as provided in § 115. So far as here relevant, § 115(a) defines a dividend as "any distribution made by a corporation to ...