Before LUMBARD, Chief Judge, and MEDINA and FRIENDLY, Circuit Judges.
This appeal is by a personal holding company from an order of Judge Dawson in the Southern District of New York, dismissing its complaint in a suit for refund of a tax on undistributed personal holding company income. In determining the amount of such income, upon which severe taxes are imposed, § 545(b)(5) of the Internal Revenue Code of 1954 permits deduction of net longterm capital gains*fn1 after reduction of these by federal income taxes attributable to them. This suit requires interpretation of the statutory direction for calculating how much tax is "attributable" to the capital gains.
Special provision for the taxation of personal holding companies began with § 351 of the Revenue Act of 1934, 48 Stat. 751. The object was "to devise a tax which would be levied automatically against corporations coming within the definition * * * without the necessity of proving a purpose of avoiding income taxes on the shareholders." 7 Mertens, Law of Federal Income Taxation, § 40.02 (1956). The device used by Congress was a high tax rate on "Undistributed personal holding company income," this "pressure" rate being intended "not so much to produce revenue as to cause an abandonment of the use of personal holding companies * * *" Id. § 40.03. The definitions of "undistributed personal holding company income" have varied. Section 545(a) of the 1954 Code, here applicable, defines this as "the taxable income of a personal holding company adjusted in the manner provided in subsection (b), minus the dividends paid deduction as defined in section 561."
Three adjustments provided in § 545(b) for determination of undistributed personal holding company income are important in this case. Paragraph (1) allows deduction of "Federal income and excess profits taxes"; this is because amounts paid out in taxes do not remain in the corporate coffers, enriching the stockholders while escaping the graduated personal tax rates. Paragraph (3) disallows "the special deductions" for intercorporate dividends received, provided in various sections of the Code; allowance of any such deduction would frustrate one of the prime purposes of the tax, namely, to prevent what in substance is dividend income of individuals from escaping surtaxes. Paragraph (5) reads as follows:
"(5) Long-term capital gains. - There shall be allowed as a deduction the excess of the net long-term capital gain for the taxable year over the net short-term capital loss for such year, minus the taxes imposed by this subtitle attributable to such excess. The taxes attributable to such excess shall be an amount equal to the difference between -
"(A) the taxes imposed by this subtitle (except the tax imposed by this part) for such year, and
"(B) such taxes computed for such year without including such excess in taxable income."
The rationale of this is that, the capital gains tax rate on individuals being no higher than it is on corporations, the stockholder derives no tax advantage from realization of such profits through the corporation, but that, since § 545(b)(1) already provides for deduction of all federal income taxes paid, the corporation would be permitted in effect to deduct the amount of its capital gains tax twice unless the deduction was reduced by the taxes "attributable" to such gain as defined in the second sentence of § 545(b)(5), the subject of this controversy.
For 1957 the taxpayer, Litchfield Securities Corporation, reported taxable income of $51,153.36, as follows:
Dividends from Domestic Corporations $249,920.48
Dividends from Foreign Corporations $10,650.00
Net Long Term Capital Gain $48,410.14