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INCOME TAX

DIFFERENCE BETWEEN CAPITAL AND INCOME

EN BANC

[G.R. No. 12287. August 7, 1918.]

VICENTE MADRIGAL and his wife, SUSANA PATERNO, plaintiffs- appellants, vs. JAMES J. RAFFERTY, Collector of Internal Revenue, and VENANCIO CONCEPCION, Deputy Collector of Internal Revenue, defendants-appellees.

Gregorio Araneta, for appellants.

Assistant Attorney Round, for appellees.

SYLLABUS

1. TAXATION; INCOME TAX; PURPOSES. — The Income Tax Law of the United

States in force in the Philippine Islands has selected income as the test of faculty in taxation.

The aim has been to mitigate the evils arising from the inequalities of wealth by a progressive scheme of taxation, which places the burden on those best able to pay. To carry out this idea, public considerations have demanded an exemption roughly equivalent to the minimum of subsistence. With these exceptions, the Income Tax Law is supposed to reach the earnings of the entire non-governmental property of the country.

2. ID.; ID.; INCOME CONTRACTED WITH CAPITAL AND PROPERTY. — Income

as contrasted with capital or property is to be the test. The essential difference between capital and income is that capital is a fund; income is a flow. Capital is wealth, while income is the service of wealth. "The fact is that property is a tree, income is the fruit; labor is a tree, income the fruit; capital is a tree, income the fruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.)

3. ID.; ID.; "INCOME:," DEFINED. — Income means profits or gains.

4. ID.; ID.; CONJUGAL PARTNERSHIPS. — The decisions of this court in Nable

Jose vs. Nable Jose [1916], 16 Off. Gaz., 871, and Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265, approved and followed. The provisions of the Civil Code

concerning conjugal partnerships have no application to the Income Tax Law.

5. ID.; ID.; ID. — M and P were legally married prior to January 1, 1914. The

marriage was contracted under the provisions concerning conjugal partnerships. The claim is submitted that the income shown on the form presented for 1914 was in fact the income of the conjugal partnership existing between M and P, and that in computing and assessing

the additional income tax, the income declared by M should be divided into two equal parts, one-half to be considered the income of M and the other half the income of P. Held: That P, the wife of M, has an inchoate right in the property of her husband M during the life of the conjugal partnership, but that P has no absolute right to one-half of the income of the conjugal partnership.

6. ID.; ID.; ID. — The higher schedules of the additional tax provided by the Income

Tax Law directed at the incomes of the wealthy may not be partially defeated by reliance on provisions in our Civil Code dealing with the conjugal partnership. The aims and purposes of the Income Tax Law must be given effect.

7. ID.; ID.; ID. — The Income Tax Law does not look on the spouses as individual

partners in an ordinary partnership.

8. ID.; ID.; STATUTORY CONSTRUCTION. — The Income Tax Law, being a law of

American origin and being peculiarly intricate in its provisions, the authoritative decision of the official charged with enforcing it has peculiar force for the Philippines. Great weight should be given to the construction placed upon a revenue law, whose meaning is doubtful, by the department charged with its execution

MALCOLM, J p:

D E C I S I O N

This appeal calls for consideration of the Income Tax Law, a law of American origin, with reference to the Civil Code, a law of Spanish origin.

STATEMENT OF THE CASE

Vicente Madrigal and Susana Paterno Were legally married prior to January 1, 1914. The marriage was contracted under the provisions of law concerning conjugal partnerships (sociedad de gananciales) . On February 25, 1915, Vicente Madrigal filed a sworn declaration on the prescribed form with the Collector of Internal Revenue, showing, as his total net income for the year 1914, the sum of P296,302.73. Subsequently Madrigal submitted the claim that the said P296,302.73 did not represent his income for the year 1914, but was in fact the income of the conjugal partnership existing between himself and his wife Susana Paterno, and that in computing and assessing the additional income tax provided by the Act of Congress of October 3, 1913, the income declared by Vicente Madrigal should be divided into two equal parts, one-half to be considered the income of Vicente Madrigal and the other half the income of Susana Paterno. The general question had in the meantime been submitted to the Attorney-General of the Philippine Islands who in an opinion dated March 17, 1915, held with the petitioner Madrigal. The revenue officers being still unsatisfied, the correspondence together with this opinion was forwarded to Washington for a decision by the United States Treasury

Department. The United States Commissioner of Internal Revenue reversed the opinion of the Attorney-General, and thus decided against the claim of Madrigal.

After payment under protest, and after the protest of Madrigal had been decided adversely by the Collector of Internal Revenue, action was begun by VicenteMadrigal and his wife Susana Paterno in the Court of First Instance of the city of Manila against the Collector of Internal Revenue and the Deputy Collector of Internal Revenue for the recovery of the sum of P3,786.08, alleged to have been wrongfully and illegally assessed and collected by the defendants from the plaintiff, VicenteMadrigal, under the provisions of the Act of Congress known as the Income Tax Law. The burden of the complaint was that if the income tax for the year 1914 had been correctly and lawfully computed there would have been due and payable by each of the plaintiffs the sum of P2,921.09, which taken together amounts to a total of P5,842.18 instead of P9,668.21, erroneously and unlawfully collected from the plaintiff Vicente Madrigal, with the result that plaintiff Madrigal has paid ' as income tax for the year 1914, P3,786.08, in excess of the sum lawfully due and payable.

The answer of the defendants, together with an analysis of the tax declaration, the pleadings, and the stipulation, sets forth the basis of defendants' stand in the following way:

The income of Vicente Madrigal and his wife Susana Paterno for the year 1914 was made up of three items: (1) P362,407.67, the profits made by Vicente Madrigal in his coal and shipping business; (2) P4,086.50, the profits made by Susana Paterno in her embroidery business; (3) P16,687.80, the profits made by Vicente Madrigal in a pawnshop company. The sum of these three items is P383,181.97, the gross income of Vicente Madrigal and Susana Paterno for the year 1914. General deductions were claimed and allowed in the sum of P86,879.24. The resulting net income was P296,302.73. For the purpose of assessing the normal tax of one per cent on the net income there were allowed as specific deductions the following: (1) P16,687.80, the tax upon which was to be paid at source, and (2) P8,000, the specific exemption granted to Vicente Madrigal and Susana Paterno, husband and wife. The remainder, P271,614.93 was the sum upon which the normal tax of one per cent was assessed. The normal tax thus arrived at was P2,716.15.

The dispute between the plaintiffs and the defendants concerned the additional tax provided for in the Income Tax Law. The trial court in an exhausted decision found in favor of defendants, without costs.

ISSUES.

The contentions of plaintiffs and appellants, having to do solely with the additional income tax, is that it should be divided into two equal parts, because of the conjugal partnership existing between them. The learned argument of counsel is mostly based upon the provisions of the Civil Code establishing the sociedad de gananciales. The counter contentions of appellees are that the taxes imposed by the Income Tax Law are as the name implies taxes upon income and not upon capital and property; that the fact that Madrigal was a married man, and his marriage contracted under the provisions governing the conjugal partnership, has no bearing on income considered as income, and that the distinction must be drawn between the ordinary form of commercial partnership and the conjugal partnership of spouses resulting from the relation of marriage.

DECISION.

From the point of view of test of faculty in taxation, no less than five answers have been given in the course of history. The final stage has been the selection of income as the norm of taxation. (See Seligman, "The Income Tax," Introduction.) The Income Tax Law of the United States, extended to the Philippine Islands, is the result of an effect on the part of legislators to put into statutory form this canon of taxation and of social reform. The aim has been to mitigate the evils arising from inequalities of wealth by a progressive scheme of taxation, which places the burden on those best able to pay. To carry out this idea, public considerations have demanded an exemption roughly equivalent to the minimum of subsistence. With these exceptions, the income tax is supposed to reach the earnings of the entire non governmental property of the country. Such is the background of the Income Tax Law.

Income as contrasted with capital or property is to be the test. The essential difference between capital and income is that capital is a fund; income is a flow. A fund of property existing at an instant of time is called capital. A flow of services rendered by that capital by the payment of money from it or any other benefit rendered by a fund of capital in relation to such fund through a period of time is called income. Capital is wealth, while income is the service of wealth. (See Fisher, "The Nature of Capital and Income.") The Supreme Court of Georgia expresses the thought in the following figurative language: "The fact is that property is a tree, income is the fruit; labor is a tree, income the fruit; capital is a tree, income the fruit." (Waring vs. City of Savannah [1878], 60 Ga., 93.) A tax on income is not a tax on property. "Income," as here used, can be defined as "profits or gains." (London County Council vs. Attorney-General [1901], A. C., 26; 70 L. J. K. B. N. S., 77; 83 L. T. N. S., 605; 49 Week. Rep., 686; 4 Tax Cas., 265. See further Foster's Income Tax, second edition [1915.], Chapter IV; Black on Income Taxes, second edition [1915], Chapter VIII; Gibbons vs. Mahon [1890], 136 U. S., 549; and Towne vs. Eisner, decided by the United States Supreme Court, January 7, 1918.)

A regulation of the United States Treasury Department relative to returns by the husband and wife not living apart, contains the following:

"The husband, as the head and legal representative of the household and general custodian of its income, should make and render the return of the aggregate income of himself and wife, and for the purpose of levying the income tax it is assumed that he can ascertain the total amount of said income. If a wife has a separate estate managed by herself as her own separate property, and receives an income of more than $3,000, she may make return of her own income, and if the husband has other net income, making the aggregate of both incomes more than $4,000, the wife's return should be attached to the return of her husband, or his income should be included in her return, in order that a deduction of $4,000 may be made from the aggregate of both incomes. The tax in such case, however, will be imposed only upon so much of the aggregate income of both as shall exceed $4,000. If either

husband or wife separately has an income equal to or in excess of $3,000, a return of annual net income is required under the law, and such return must include the income of both, and in such case the return must be made even though the combined income of both be less than $4,000. If the aggregate net income of both exceeds $4,000, an annual return of their combined incomes must be made in the manner stated, although neither one separately has an income of $3,000 per annum. They are jointly and separately liable for such return and for the payment of the tax. The single or married status of the person claiming the specific exemption shall be determined as of the time of claiming such exemption if such claim be made within the year for which return is made, otherwise the status at the close of the year."

With these general observations relative to the Income Tax Law in force in the Philippine Islands, we turn for a moment to consider the provisions of the Civil Code dealing with the conjugal partnership. Recently in two elaborate decisions in which a long line of Spanish authorities were cited, this court, in speaking of the conjugal partnership, decided that "prior to the liquidation, the interest of the wife, and in case of her death, of her heirs, is an interest inchoate, a mere expectancy, which constitutes neither a legal nor an equitable estate, and does not ripen into title until there appears that there are assets in the community as a result of the liquidation and settlement." (Nable Jose vs. Nable Jose [1916], 15 Off. Gaz., 871; Manuel and Laxamana vs. Losano [1918], 16 Off. Gaz., 1265.)

Susana Paterno, wife of Vicente Madrigal, has an inchoate right in the property of her husband Vicente Madrigal during the life of the conjugal partnership. She has an interest in the ultimate property rights and in the ultimate ownership of property acquired as income after such income has become capital. Susana Paterno has no absolute right to one-half the income of the conjugal partnership. Not being seized of a separate estate, Susana Paterno cannot make a separate return in order to receive the benefit of the exemption which would arise by reason of the additional tax. As she has no estate and income, actually and legally vested in her and entirely distinct from her husband's property, the income cannot properly be considered the separate income of the wife for the purposes of the additional tax. Moreover, the Income Tax Law does not look on the spouses as individual partners in an ordinary partnership. The husband and wife are only entitled to the exemption of P8,000, specifically granted by the law. The higher schedules of the additional tax directed at the incomes of the wealthy may not be partially defeated by reliance on provisions in our Civil Code dealing with the conjugal partnership and having no application to the Income Tax Law. The aims and purposes of the Income Tax Law must be given effect.

The point we are discussing has heretofore been considered by the Attorney- General of the Philippine Islands and the United States Treasury Department. The decision of the latter overruling the opinion of the Attorney-General is as follows:

"TREASURY DEPARTMENT, Washington.

"Income Tax.

"FRANK MCINTYRE,

"Chief, Bureau of Insular Affairs, War Department,

"Washington, D.C.

"SIR: This office is in receipt of your letter of June 22, 1915, transmitting copy of correspondence 'from the Philippine authorities relative to the method of submission of income tax returns by married persons.'

"You advise that 'The Governor-General, in forwarding the papers to the Bureau, advises that the Insular Auditor has been authorized to suspend action on the warrants in question until an authoritative decision on the points raised can be secured from the Treasury Department.'

"From the correspondence it appears that Gregorio Araneta, married and living with his wife, had an income of an amount sufficient to require the imposition of the additional tax provided by the statute; that the net income was properly computed and then both income and deductions and the specific exemption were divided in half and two returns made, one return for each half in the names respectively of the husband and wife, so that under the returns as filed there would be an escape from the additional tax; that Araneta claims the returns are correct on the ground that under the Philippine law his wife is entitled to half of his earnings; that Araneta has dominion over the income and under the Philippine law, the right to determine its use and disposition; that in this case the wife has no 'separate estate' within the contemplation of the Act of October 3, 1913, levying an income tax.

"It appears further from the correspondence that upon the foregoing explanation, tax was assessed against the entire net income against Gregorio Araneta; that the tax was paid and an application for refund made, and that the application for refund was rejected, whereupon the matter was submitted to the Attorney-General of the Islands who holds that the returns were correctly rendered, and that the refund should be allowed; and thereupon the question at issue is submitted through the Governor-General of the Islands and Bureau of Insular Affairs for the advisory opinion of this office.

"By paragraph M of the statute, its provisions are extended to the Philippine Islands, to be administered as in the United States but by the appropriate internal-revenue officers of the Philippine Government. You are therefore advised that upon the facts as stated, this office holds that for the Federal Income Tax (Act of October 3, 1913), the entire net income in this case was taxable to Gregorio Araneta, both for the normal and additional tax, and that the application for refund was properly rejected.

"The separate estate of a married woman within the contemplation of the Income Tax Law is that which belongs to her solely and separate and apart

from her husband, and over which her husband has no right in equity. It may consist of lands or chattels.

"The statute and the regulations promulgated in accordance therewith provide that each person of lawful age (not excused from so doing) having a net income of $3,000 or over for the taxable year shall make a return showing the facts; that from the net income so shown there shall be deducted $3,000 where the person making the return is a single person, or married and not living with consort, and $1,000 additional where the person making the return is married and living with consort; but that where the husband and wife both make returns (they living together), the amount of deduction from the aggregate of their several incomes shall not exceed $4,000.

"The only occasion for a wife making a return is where she has income from a sole and separate estate in excess of $3,000, or where the husband and wife neither separately have an income of $3,000, but together they have an income in excess of $4,000, in which latter event either the husband or wife may make the return but not both. In all instances the income of husband and wife whether from separate estates or not, is taken as a whole for the purpose of the normal tax. Where the wife has income from a separate estate and makes return thereof, or where her income is separately shown in the return made by her husband, while the incomes are added together for the purpose of the normal tax they are taken separately for the purpose of the additional tax. In this case, however, the wife has no separate income within the contemplation of the Income Tax Law.

"Respectfully,

"DAVID A. GATES,

"Acting Commissioner."

In connection with the decision above quoted, it is well to recall a few basic ideas. The Income Tax Law was drafted by the Congress of the United States and has been by the Congress extended to the Philippine Islands. Being thus a law of American origin and being peculiarly intricate in its provisions, the authoritative decision of the official who is charged with enforcing it has peculiar force for the Philippines. It has come to be a well-settled rule that great weight should be given to the construction placed upon a revenue law, whose meaning is doubtful, by the department charged with its execution. (U. S. vs. Cerecedo Hermanos y Cia. [1907], 209 U. S., 338; In re Allen [1903], 2 Phil., 630; Government of the Philippine Islands vs. Municipality of Binalonan, and Roman Catholic Bishop of Nueva Segovia [1915], 32 Phil., 634.)

We conclude that the judgment should be as it is hereby affirmed with costs against appellants. So ordered

Torres, Johnson, Carson, Street and Fisher, JJ.; concur.

REALIZATION TEST/ SEVERANCE THEORY

Eisner v. Macomber

No. 318

Argued April 16, 1919

Restored to docket for reargument May 19, 1919

Reargued October 17, 20, 1919

Decided March 8, 1920

252 U.S. 189

ERROR TO THE DISTRICT COURT OF THE UNITED STATES

FOR THE SOUTHERN DISTRICT OF NEW YORK

Syllabus

Congress was not empowered by the Sixteenth Amendment to tax, as income of the stockholder, without apportionment, a stock dividend made lawfully and in good faith against profits accumulated by the corporation since March 1, 1913. P.252 U. S. 201. Towne v. Eisner, 245 U. S. 418.

The Revenue Act of September 8, 1916, c. 463, 39 Stat. 756, plainly evinces the purpose of Congress to impose such taxes, and is to that extent in conflict with Art. I, § 2, cl. 3, and Art. I, § 9, cl. 4, of the Constitution. Pp. 252 U. S. 199, 252 U. S. 217.

These provisions of the Constitution necessarily limit the extension, by construction, of the Sixteenth Amendment. P. 252 U. S. 205.

What is or is not "income" within the meaning of the Amendment must be determined in each case according to truth and substance, without regard to form. P. 252 U. S. 206.

Income may be defined as the gain derived from capital, from labor, or from both combined, including profit gained through sale or conversion of capital. P. 252 U. S. 207.

Mere growth or increment of value in a capital investment is not income; income is essentially a gain or profit, in itself, of exchangeable value, proceeding from capital, severed from it, and derived or received by the taxpayer for his separate use, benefit, and disposal. Id.

A stock dividend, evincing merely a transfer of an accumulated surplus to the capital account of

the corporation, takes nothing from the property of the corporation and adds nothing to that of the shareholder; a tax on such dividends is a tax an capital increase, and not on income, and, to be valid under the Constitution, such taxes must be apportioned according to population in the several states. P. 252 U. S. 208.

Affirmed.

Page 252 U. S. 190

The case is stated in the opinion.

Page 252 U. S. 199

MR. JUSTICE PITNEY delivered the opinion of the Court.

This case presents the question whether, by virtue of the Sixteenth Amendment, Congress has

the power to tax, as income of the stockholder and without apportionment, a stock dividend made lawfully and in good faith against profits accumulated by the corporation since March 1,

1913.

It arises under the Revenue Act of September 8, 1916, 39 Stat. 756 et seq., which, in our opinion (notwithstanding a contention of the government that will be

Page 252 U. S. 200

noticed), plainly evinces the purpose of Congress to tax stock dividends as income. *

The facts, in outline, are as follows:

On January 1, 1916, the Standard Oil Company of California, a corporation of that state, out of an authorized capital stock of $100,000,000, had shares of stock outstanding, par value $100 each, amounting in round figures to $50,000,000. In addition, it had surplus and undivided profits invested in plant, property, and business and required for the purposes of the corporation, amounting to about $45,000,000, of which about $20,000,000 had been earned prior to March 1, 1913, the balance thereafter. In January, 1916, in order to readjust the capitalization, the board of directors decided to issue additional shares sufficient to constitute a stock dividend of 50 percent of the outstanding stock, and to transfer from surplus account to capital stock account an amount equivalent to such issue. Appropriate resolutions were adopted, an amount equivalent to the par value of the proposed new stock was transferred accordingly, and the new stock duly issued against it and divided among the stockholders.

Defendant in error, being the owner of 2,200 shares of the old stock, received certificates for 1, 100 additional

Page 252 U. S. 201

shares, of which 18.07 percent, or 198.77 shares, par value $19,877, were treated as representing surplus earned between March 1, 1913, and January 1, 1916. She was called upon to pay, and did pay under protest, a tax imposed under the Revenue Act of 1916, based upon a supposed income of $19,877 because of the new shares, and, an appeal to the Commissioner of Internal Revenue having been disallowed, she brought action against the Collector to recover the tax. In her complaint, she alleged the above facts and contended that, in imposing such a tax the Revenue Act of 1916 violated article 1, § 2, cl. 3, and Article I, § 9, cl. 4, of the Constitution of the United States, requiring direct taxes to be apportioned according to population, and that the stock dividend was not income within the meaning of the Sixteenth Amendment. A general demurrer to the complaint was overruled upon the authority of Towne v. Eisner, 245 U. S. 418, and, defendant having failed to plead further, final judgment went against him. To review it, the present writ of error is prosecuted.

The case was argued at the last term, and reargued at the present term, both orally and by additional briefs.

We are constrained to hold that the judgment of the district court must be affirmed, first, because the question at issue is controlled by Towne v. Eisner, supra; secondly, because a reexamination of the question with the additional light thrown upon it by elaborate arguments has confirmed the view that the underlying ground of that decision is sound, that it disposes of the question here presented, and that other fundamental considerations lead to the same result.

In Towne v. Eisner, the question was whether a stock dividend made in 1914 against surplus earned prior to January 1, 1913, was taxable against the stockholder under the Act of October 3, 1913, c. 16, 38 Stat. 114, 166, which provided (§ B, p. 167) that net income should include "dividends," and also "gains or profits and income derived

Page 252 U. S. 202

from any source whatever." Suit having been brought by a stockholder to recover the tax assessed against him by reason of the dividend, the district court sustained a demurrer to the complaint. 242 F. 702. The court treated the construction of the act as inseparable from the interpretation of the Sixteenth Amendment; and, having referred to Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, and quoted the Amendment, proceeded very properly to say (p. 704):

"It is manifest that the stock dividend in question cannot be reached by the Income Tax Act and could not, even though Congress expressly declared it to be taxable as income, unless it is in fact income."

It declined, however, to accede to the contention that, in Gibbons v. Mahon, 136 U. S. 549, "stock dividends" had received a definition sufficiently clear to be controlling, treated the language of this Court in that case as obiter dictum in respect of the matter then before it (p.

706), and examined the question as res nova, with the result stated. When the case came here, after overruling a motion to dismiss made by the government upon the ground that the only question involved was the construction of the statute, and not its constitutionality, we dealt upon the merits with the question of construction only, but disposed of it upon consideration of the essential nature of a stock dividend disregarding the fact that the one in question was based upon surplus earnings that accrued before the Sixteenth Amendment took effect. Not only so, but we rejected the reasoning of the district court, saying (245 U.S. 245 U. S. 426):

"Notwithstanding the thoughtful discussion that the case received below we cannot doubt that the dividend was capital as well for the purposes of the Income Tax Law as for distribution between tenant for life and remainderman. What was said by this Court upon the latter question is equally true for the former."

"A stock dividend really takes nothing from the property of the corporation, and adds nothing to the

Page 252 U. S. 203

interests of the shareholders. Its property is not diminished, and their interests are not The proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones."

"Gibbons v. Mahon, 136 U. S. 549, 136 U. S. 559-560. In short, the corporation is no poorer and

the stockholder is no richer than they were before. Logan County v. United States, 169 U. S. 255, 169 U. S. 261. If the plaintiff gained any small advantage by the change, it certainly was

not an advantage of $417,450, the sum upon which he was

that the plaintiff's old certificates have been split up in effect and have diminished in value to the extent of the value of the new."

What has happened is

This language aptly answered not only the reasoning of the district court, but the argument of the Solicitor General in this Court, which discussed the essential nature of a stock dividend. And if, for the reasons thus expressed, such a dividend is not to be regarded as "income" or "dividends" within the meaning of the Act of 1913, we are unable to see how it can be brought within the meaning of "incomes" in the Sixteenth Amendment, it being very clear that Congress intended in that act to exert its power to the extent permitted by the amendment. In Towne v. Eisner, it was not contended that any construction of the statute could make it narrower than the constitutional grant; rather the contrary.

The fact that the dividend was charged against profits earned before the Act of 1913 took effect, even before the amendment was adopted, was neither relied upon nor alluded to in our consideration of the merits in that case. Not only so, but had we considered that a stock

dividend constituted income in any true sense, it would have been held taxable under the Act of 1913 notwithstanding it was

Page 252 U. S. 204

based upon profits earned before the amendment. We ruled at the same term, in Lynch v. Hornby, 247 U. S. 339, that a cash dividend extraordinary in amount, and in Peabody v. Eisner, 247 U. S. 347, that a dividend paid in stock of another company, were taxable as income although based upon earnings that accrued before adoption of the amendment. In the former case, concerning "corporate profits that accumulated before the act took effect," we declared (pp. 247 U. S. 343-344):

"Just as we deem the legislative intent manifest to tax the stockholder with respect to such accumulations only if and when, and to the extent that, his interest in them comes to fruition as income, that is, in dividends declared, so we can perceive no constitutional obstacle that stands in the way of carrying out this intent when dividends are declared out of a preexisting . Congress was at liberty under the amendment to tax as income, without apportionment, everything that became income, in the ordinary sense of the word, after the adoption of the amendment, including dividends received in the ordinary course by a stockholder from a corporation, even though they were extraordinary in amount and might appear upon analysis to be a mere realization in possession of an inchoate and contingent interest that the stockholder had in a surplus of corporate assets previously existing."

In Peabody v. Eisner, 247 U. S. 349, 247 U. S. 350, we observed that the decision of the district court in Towne v. Eisner had been reversed

"only upon the ground that it related to a stock dividend which in fact took nothing from the property of the corporation and added nothing to the interest of the shareholder, but merely changed the evidence which represented that interest,"

and we distinguished the Peabody case from the Towne case upon the ground that "the dividend of Baltimore & Ohio shares was not a stock dividend but a distribution in specie of a portion of the assets of the Union Pacific."

Therefore, Towne v. Eisner cannot be regarded as turning

Page 252 U. S. 205

upon the point that the surplus accrued to the company before the act took effect and before adoption of the amendment. And what we have quoted from the opinion in that case cannot be regarded as obiter dictum, it having furnished the entire basis for the conclusion reached. We adhere to the view then expressed, and might rest the present case there not because that case in terms decided the constitutional question, for it did not, but because the conclusion there reached as to the essential nature of a stock dividend necessarily prevents its being regarded as income in any true sense.

Nevertheless, in view of the importance of the matter, and the fact that Congress in the

Revenue Act of 1916 declared (39 Stat. 757) that a "stock dividend shall be considered income,

to the amount of its cash value," we will deal at length with the constitutional question,

incidentally testing the soundness of our previous conclusion.

The Sixteenth Amendment must be construed in connection with the taxing clauses of the original Constitution and the effect attributed to them before the amendment was adopted.

In Pollock v. Farmers' Loan & Trust Co., 158 U. S. 601, under the Act of August 27, 1894, c.

349, § 27, 28 Stat. 509, 553, it was held that taxes upon rents and profits of real estate and upon returns from investments of personal property were in effect direct taxes upon the property from which such income arose, imposed by reason of ownership, and that Congress could not impose such taxes without apportioning them among the states according to population, as required by Article I, § 2, cl. 3, and § 9, cl. 4, of the original Constitution.

Afterwards, and evidently in recognition of the limitation upon the taxing power of Congress thus determined, the Sixteenth Amendment was adopted, in words lucidly expressing the object to be accomplished:

"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among

Page 252 U. S. 206

the several states and without regard to any census or enumeration."

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 v. Union Pacific R. Co.,240 U. S. 1, 240 U. S. 17-19; Stanton v. Baltic Mining Co., 240 U. S. 103, 240 U. S. 112 et seq.; Peck & Co. v. Lowe, 247 U. S. 165,247 U. S.

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 construction, so as to repeal or modify, except as applied to income, those provisions of the Constitution that require an apportionment according

to population for direct taxes upon property, real and personal. This limitation still has an

appropriate and important function, and is not to be overridden by Congress or disregarded by

the courts.

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 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 fundamental relation of "capital" to "income" has been much discussed by economists, 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,"

Page 252 U. S. 207

as used in common 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.

After examining dictionaries in common use (Bouv. L.D.; Standard Dict.; Webster's Internat. Dict.; Century Dict.), we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909 (Stratton's Independence v. Howbert, 231 U. S. 399, 231 U. S. 415; Doyle v. Mitchell Bros. Co., 247 U. S. 179, 247 U. S. 185), "Income may be defined as the gain derived from capital, from labor, or from both combined," provided 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. 247 U. S. 183-185.

Brief as it is, it indicates the characteristic and distinguishing attribute of income essential for a correct solution of the present controversy. The government, although basing its argument upon the definition as quoted, placed chief emphasis upon the word "gain," which was extended to include a variety of meanings; while the significance of the next three words was either overlooked or misconceived. "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 investment; but a gain, a profit, something of exchangeable 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.

The same fundamental conception is clearly set forth in the Sixteenth Amendment -- "incomes, from whatever source derived" -- the essential thought being expressed

Page 252 U. S. 208

with a conciseness and lucidity entirely in harmony with the form and style of the Constitution.

Can a stock dividend, considering its essential character, be brought within the definition? To answer this, regard must be had to the nature of a corporation and the stockholder's relation to

it. We refer, of course, to a corporation such as the one in the case at bar, organized for profit, and having a capital stock divided into shares to which a nominal or par value is attributed.

Certainly the interest of the stockholder is a capital interest, and his certificates of stock are but the evidence of it. They state the number of shares to which he is entitled and indicate their par value and how the stock may be transferred. They show that he or his assignors, immediate or remote, have contributed capital to the enterprise, that he is entitled to a corresponding interest proportionate to the whole, entitled to have the property and business of the company devoted during the corporate existence to attainment of the common objects, entitled to vote at stockholders' meetings, to receive dividends out of the corporation's profits if and when declared, and, in the event of liquidation, to receive a proportionate share of the net assets, if any, remaining after paying creditors. Short of liquidation, or until dividend declared, he has no right to withdraw any part of either capital or profits from the common enterprise; on the contrary, his interest pertains not to any part, divisible or indivisible, but to the entire assets, business, and affairs of the company. Nor is it the interest of an owner in the assets themselves, since the corporation has full title, legal and equitable, to the whole. The stockholder has the right to have the assets employed in the enterprise, with the incidental rights mentioned; but, as stockholder, he has no right to withdraw, only the right to persist, subject to the risks of the enterprise, and looking only to dividends for his return. If he desires to dissociate himself

Page 252 U. S. 209

from the company, he can do so only by disposing of his stock.

For bookkeeping purposes, the company acknowledges a liability in form to the stockholders equivalent to the aggregate par value of their stock, evidenced by a "capital stock account." If profits have been made and not divided, they create additional bookkeeping liabilities under the head of "profit and loss," "undivided profits," "surplus account," or the like. None of these, however, gives to the stockholders as a body, much less to any one of them, either a claim against the going concern for any particular sum of money or a right to any particular portion of the assets or any share in them unless or until the directors conclude that dividends shall be made and a part of the company's assets segregated from the common fund for the purpose. The dividend normally is payable in money, under exceptional circumstances in some other divisible property, and when so paid, then only (excluding, of course, a possible advantageous sale of his stock or winding-up of the company) does the stockholder realize a profit or gain which becomes his separate property, and thus derive income from the capital that he or his predecessor has invested.

In the present case, the corporation had surplus and undivided profits invested in plant, property, and business, and required for the purposes of the corporation, amounting to about $45,000,000, in addition to outstanding capital stock of $50,000,000. In this, the case is not extraordinary. The profits of a corporation, as they appear upon the balance sheet at the end of the year, need not be in the form of money on hand in excess of what is required to meet current liabilities and finance current operations of the company. Often, especially in a growing

business, only a part, sometimes a small part, of the year's profits is in property capable of division, the remainder having been absorbed in the acquisition of increased plant,

Page 252 U. S. 210

equipment, stock in trade, or accounts receivable, or in decrease of outstanding liabilities. When only a part is available for dividends, the balance of the year's profits is carried to the credit of undivided profits, or surplus, or some other account having like significance. If thereafter the company finds itself in funds beyond current needs, it may declare dividends out of such surplus or undivided profits; otherwise it may go on for years conducting a successful business, but requiring more and more working capital because of the extension of its operations, and therefore unable to declare dividends approximating the amount of its profits. Thus, the surplus may increase until it equals or even exceeds the par value of the outstanding capital stock. This may be adjusted upon the books in the mode adopted in the case at bar -- by declaring a "stock dividend." This, however, is no more than a book adjustment, in essence -- not a dividend, but rather the opposite; no part of the assets of the company is separated from the common fund, nothing distributed except paper certificates that evidence an antecedent increase in the value

of the stockholder's capital interest resulting from an accumulation of profits by the company,

but profits so far absorbed in the business as to render it impracticable to separate them for withdrawal and distribution. In order to make the adjustment, a charge is made against surplus account with corresponding credit to capital stock account, equal to the proposed "dividend;" the new stock is issued against this and the certificates delivered to the existing stockholders in proportion to their previous holdings. This, however, is merely bookkeeping that does not affect the aggregate assets of the corporation or its outstanding liabilities; it affects only the form, not the essence, of the "liability" acknowledged by the corporation to its own shareholders, and this through a readjustment of accounts on one side of the balance sheet only, increasing "capital stock" at the expense of

Page 252 U. S. 211

"surplus"; it does not alter the preexisting proportionate interest of any stockholder or increase the intrinsic value of his holding or of the aggregate holdings of the other stockholders as they stood before. The new certificates simply increase the number of the shares, with consequent dilution of the value of each share.

A

"stock dividend" shows that the company's accumulated profits have been capitalized, instead

of

distributed to the stockholders or retained as surplus available for distribution in money or in

kind should opportunity offer. Far from being a realization of profits of the stockholder, it tends

rather to postpone such realization, in that the fund represented by the new stock has been transferred from surplus to capital, and no longer is available for actual distribution.

The essential and controlling fact is that the stockholder has received nothing out of the company's assets for his separate use and benefit; on the contrary, every dollar of his original investment, together with whatever accretions and accumulations have resulted from

employment of his money and that of the other stockholders in the business of the company, still remains the property of the company, and subject to business risks which may result in wiping out the entire investment. Having regard to the very truth of the matter, to substance and not to form, he has received nothing that answers the definition of income within the meaning of the Sixteenth Amendment.

Being concerned only with the true character and effect of such a dividend when lawfully made, we lay aside the question whether, in a particular case, a stock dividend may be authorized by the local law governing the corporation, or whether the capitalization of profits may be the result of correct judgment and proper business policy on the part of its management, and a due regard for the interests of the stockholders. And we are considering the taxability of bona fide stock dividends only.

Page 252 U. S. 212

We are clear that not only does a stock dividend really take nothing from the property of the corporation and add nothing to that of the shareholder, but that the antecedent accumulation of profits evidenced thereby, while indicating that the shareholder is the richer because of an increase of his capital, at the same time shows he has not realized or received any income in the transaction.

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. The same would be true were he to sell some of his original shares at a profit. But if a shareholder sells dividend stock, he necessarily disposes of a part of his capital interest, just as if he should sell a part of his old stock, either before or after the dividend. What he retains no longer entitles him to the same proportion of future dividends as before the sale. His part in the control of the company likewise is diminished. Thus, if one holding $60,000 out of a total $100,000 of the capital stock of a corporation should receive in common with other stockholders a 50 percent stock dividend, and should sell his part, he thereby would be reduced from a majority to a minority stockholder, having six-fifteenths instead of six-tenths of the total stock outstanding. A corresponding and proportionate decrease in capital interest and in voting power would befall a minority holder should he sell dividend stock, it being in the nature of things impossible for one to dispose of any part of such an issue without a proportionate disturbance of the distribution of the entire capital stock and a like diminution of the seller's comparative voting power -- that "right preservative of rights" in the control of a corporation.

Page 252 U. S. 213

Yet, without selling, the shareholder, unless possessed of other resources, has not the wherewithal to pay an income tax upon the dividend stock. Nothing could more clearly show that

to tax a stock dividend is to tax a capital increase, and not income, than this demonstration that, in the nature of things, it requires conversion of capital in order to pay the tax.

Throughout the argument of the government, in a variety of forms, runs the fundamental error already mentioned -- a failure to appraise correctly the force of the term "income" as used in the Sixteenth Amendment, or at least to give practical effect to it. Thus, the government contends that the tax "is levied on income derived from corporate earnings," when in truth the stockholder has "derived" nothing except paper certificates, which, so far as they have any effect, deny him present participation in such earnings. It contends that the tax may be laid when earnings "are received by the stockholder," whereas he has received none; that the profits are "distributed by means of a stock dividend," although a stock dividend distributes no profits; that, under the Act of 1916, "the tax is on the stockholder's share in corporate earnings," when in truth a stockholder has no such share, and receives none in a stock dividend; that "the profits are segregated from his former capital, and he has a separate certificate representing his invested profits or gains," whereas there has been no segregation of profits, nor has he any separate certificate representing a personal gain, since the certificates, new and old, are alike in what they represent -- a capital interest in the entire concerns of the corporation.

We have no doubt of the power or duty of a court to look through the form of the corporation and determine the question of the stockholder's right in order to ascertain whether he has received income taxable by Congress without apportionment. But, looking through the form,

Page 252 U. S. 214

we cannot disregard the essential truth disclosed, ignore the substantial difference between corporation and stockholder, treat the entire organization as unreal, look upon stockholders as partners when they are not such, treat them as having in equity a right to a partition of the corporate assets when they have none, and indulge the fiction that they have received and realized a share of the profits of the company which in truth they have neither received nor realized. We must treat the corporation as a substantial entity separate from the stockholder not only because such is the practical fact, but because it is only by recognizing such separateness that any dividend -- even one paid in money or property -- can be regarded as income of the stockholder. Did we regard corporation and stockholders as altogether identical, there would be no income except as the corporation acquired it, and while this would be taxable against the corporation as income under appropriate provisions of law, the individual stockholders could not be separately and additionally taxed with respect to their several shares even when divided, since, if there were entire identity between them and the company, they could not be regarded as receiving anything from it, any more than if one's money were to be removed from one pocket to another.

Conceding that the mere issue of a stock dividend makes the recipient no richer than before, the government nevertheless contends that the new certificates measure the extent to which the gains accumulated by the corporation have made him the richer. There are two insuperable difficulties with this. In the first place, it would depend upon how long he had held the stock

whether the stock dividend indicated the extent to which he had been enriched by the operations of the company; unless he had held it throughout such operations, the measure would not hold true. Secondly, and more important for present purposes, enrichment through increase in value

Page 252 U. S. 215

of capital investment is not income in any proper meaning of the term.

The complaint contains averments respecting the market prices of stock such as plaintiff held, based upon sales before and after the stock dividend, tending to show that the receipt of the additional shares did not substantially change the market value of her entire holdings. This tends to show that, in this instance, market quotations reflected intrinsic values -- a thing they do not always do. But we regard the market prices of the securities as an unsafe criterion in an inquiry such as the present, when the question must be not what will the thing sell for, but what is it in truth and in essence.

It is said there is no difference in principle between a simple stock dividend and a case where stockholders use money received as cash dividends to purchase additional stock contemporaneously issued by the corporation. But an actual cash dividend, with a real option to the stockholder either to keep the money for his own or to reinvest it in new shares, would be as far removed as possible from a true stock dividend, such as the one we have under consideration, where nothing of value is taken from the company's assets and transferred to the individual ownership of the several stockholders and thereby subjected to their disposal.

The government's reliance upon the supposed analogy between a dividend of the corporation's own shares and one made by distributing shares owned by it in the stock of another company calls for no comment beyond the statement that the latter distributes assets of the company among the shareholders, while the former does not, and for no citation of authority except Peabody v. Eisner, 247 U. S. 347, 247 U. S. 349-350.

Two recent decisions, proceeding from courts of high jurisdiction, are cited in support of the position of the government.

Page 252 U. S. 216

Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231, arose under the Dividend Duties Act of Western Australia, which provided that "dividend" should include "every dividend, profit, advantage, or gain intended to be paid or credited to or distributed among any members or directors of any company," except, etc. There was a stock dividend, the new shares being allotted among the shareholders pro rata, and the question was whether this was a distribution of a dividend within the meaning of the act. The Judicial Committee of the Privy Council sustained the dividend duty upon the ground that, although "in ordinary language the new shares would not be called a dividend, nor would the allotment of them be a distribution of a

dividend," yet, within the meaning of the act, such new shares were an "advantage" to the recipients. There being no constitutional restriction upon the action of the lawmaking body, the case presented merely a question of statutory construction, and manifestly the decision is not a precedent for the guidance of this Court when acting under a duty to test an act of Congress by the limitations of a written Constitution having superior force.

In Tax Commissioner v. Putnam, (1917) 227 Mass. 522, it was held that the Forty-Fourth amendment to the Constitution of Massachusetts, which conferred upon the legislature full power to tax incomes, "must be interpreted as including every item which by any reasonable understanding can fairly be regarded as income" (pp. 526, 531), and that under it, a stock dividend was taxable as income, the court saying (p. 535):

"In essence, the thing which has been done is to distribute a symbol representing an accumulation of profits, which, instead of being paid out in cash, is invested in the business, thus augmenting its durable assets. In this aspect of the case, the substance of the transaction is no different from what it would be if a cash dividend had been declared with the privilege of subscription to an equivalent amount of new shares. "

Page 252 U. S. 217

We cannot accept this reasoning. Evidently, in order to give a sufficiently broad sweep to the new taxing provision, it was deemed necessary to take the symbol for the substance, accumulation for distribution, capital accretion for its opposite, while a case where money is paid into the hand of the stockholder with an option to buy new shares with it, followed by acceptance of the option, was regarded as identical in substance with a case where the stockholder receives no money and has no option. The Massachusetts court was not under an obligation, like the one which binds us, of applying a constitutional amendment in the light of other constitutional provisions that stand in the way of extending it by construction.

Upon the second argument, the government, recognizing the force of the decision in Towne v. Eisner, supra, and virtually abandoning the contention that a stock dividend increases the interest of the stockholder or otherwise enriches him, insisted as an alternative that, by the true construction of the Act of 1916, the tax is imposed not upon the stock dividend, but rather upon the stockholder's share of the undivided profits previously accumulated by the corporation, the tax being levied as a matter of convenience at the time such profits become manifest through the stock dividend. If so construed, would the act be constitutional?

That Congress has power to tax shareholders upon their property interests in the stock of corporations is beyond question, and that such interests might be valued in view of the condition of the company, including its accumulated and undivided profits, is equally clear. But that this would be taxation of property because of ownership, and hence would require apportionment under the provisions of the Constitution, is settled beyond peradventure by previous decisions of this Court.

The government relies upon Collector v. Hubbard, (1870)

Page 252 U. S. 218

12 Wall. 1, which arose under § 117 of the Act of June 30, 1864, c. 173, 13 Stat. 223, 282, providing that

"The gains and profits of all companies, whether incorporated or partnership, other than the companies specified in that section, shall be included in estimating the annual gains, profits, or income of any person, entitled to the same, whether divided or otherwise."

The court held an individual taxable upon his proportion of the earnings of a corporation although not declared as dividends and although invested in assets not in their nature divisible. Conceding that the stockholder for certain purposes had no title prior to dividend declared, the court nevertheless said (p. 79 U. S. 18):

"Grant all that, still it is true that the owner of a share of stock in a corporation holds the share with all its incidents, and that among those incidents is the right to receive all future dividends -- that is, his proportional share of all profits not then divided. Profits are incident to the share to which the owner at once becomes entitled provided he remains a member of the corporation until a dividend is made. Regarded as an incident to the shares, undivided profits are property of the shareholder, and as such are the proper subject of sale, gift, or devise. Undivided profits invested in real estate, machinery, or raw material for the purpose of being manufactured are investments in which the stockholders are interested, and when such profits are actually appropriated to the payment of the debts of the corporation, they serve to increase the market value of the shares, whether held by the original subscribers or by assignees."

Insofar as this seems to uphold the right of Congress to tax without apportionment a stockholder's interest in accumulated earnings prior to dividend declared, it must be regarded as overruled by Pollock v. Farmers' Loan & Trust Co.,158 U. S. 601, 158 U. S. 627-628, 158 U. S. 637. Conceding Collector v. Hubbard was inconsistent with the doctrine of that case, because it sustained a direct tax upon property not apportioned

Page 252 U. S. 219

among the states, the government nevertheless insists that the sixteenth Amendment removed this obstacle, so that now the Hubbard case is authority for the power of Congress to levy a tax on the stockholder's share in the accumulated profits of the corporation even before division by the declaration of a dividend of any kind. Manifestly this argument must be rejected, since the amendment applies to income only, and what is called the stockholder's share in the accumulated profits of the company is capital, not income. As we have pointed out, a stockholder has no individual share in accumulated profits, nor in any particular part of the assets of the corporation, prior to dividend declared.

Thus, from every point of view, we are brought irresistibly to the conclusion that neither under the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder. The Revenue Act of 1916, insofar as it imposes a tax upon the stockholder because of such dividend, contravenes the provisions of Article I, § 2, cl. 3, and Article I, § 9, cl. 4, of the Constitution, and to this extent is invalid notwithstanding the Sixteenth Amendment.

Judgment affirmed.

*

"Title I. -- Income Tax"

"Part I. -- On Individuals"

"Sec. 2. (a) That, subject only to such exemptions and deductions as are hereinafter allowed,

the net income of a taxable person shall include gains, profits, and income derived,

from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever:Provided, that the term 'dividends' as used in this title shall be held to mean any distribution made or ordered to be

made by a corporation,

hundred and thirteen, and payable to its shareholders, whether, in cash or in stock of the

also

out of its earnings or profits accrued since March first, nineteen

corporation,

which stock dividend shall be considered income, to the amount of its cash

value."

MR. JUSTICE HOLMES, dissenting.

I think that Towne v. Eisner, 245 U. S. 418, was right in its reasoning and result, and that, on sound principles, the stock dividend was not income. But it was clearly intimated in that case that the construction of the statute then before the Court might be different from that of the Constitution. 245 U.S. 245 U. S. 425. I think that the word "incomes" in the Sixteenth Amendment should be read in

Page 252 U. S. 220

"a sense most obvious to the common understanding at the time of its adoption." Bishop v. State, 149 Ind. 223, 230; State v. Butler, 70 Fla. 102, 133. For it was for public adoption that it was proposed. McCulloch v. Maryland, 4 Wheat. 316, 17 U. S. 407. The known purpose of this Amendment was to get rid of nice questions as to what might be direct taxes, and I cannot doubt that most people not lawyers would suppose when they voted for it that they put a question like the present to rest. I am of opinion that the Amendment justifies the tax. See Tax Commissioner v. Putnam, 227 Mass. 522, 532, 533.

MR. JUSTICE DAY concurs in this opinion.

MR. JUSTICE BRANDEIS delivered the following opinion, in which MR. JUSTICE CLARKE concurred.

Financiers, with the aid of lawyers, devised long ago two different methods by which a corporation can, without increasing its indebtedness, keep for corporate purposes accumulated

profits, and yet, in effect, distribute these profits among its stockholders. One method is a simple one. The capital stock is increased; the new stock is paid up with the accumulated profits, and the new shares of paid-up stock are then distributed among the stockholders pro rata as a dividend. If the stockholder prefers ready money to increasing his holding of the stock in the company, he sells the new stock received as a dividend. The other method is slightly more

complicated.

rata at par, and at the same time for the payment of a cash dividend equal to the amount which

the stockholder will be required to pay to

.arrangements are made for an increase of stock to be offered to stockholders pro

Page 252 U. S. 221

the company, if he avails himself of the right to subscribe for his pro rata of the new stock. If the stockholder takes the new stock, as is expected, he may endorse the dividend check received to the corporation, and thus pay for the new stock. In order to ensure that all the new stock so offered will be taken, the price at which it is offered is fixed far below what it is believed will be its market value. If the stockholder prefers ready money to an increase of his holdings of stock, he may sell his right to take new stock pro rata, which is evidenced by an assignable instrument. In that event the purchaser of the rights repays to the corporation, as the subscription price of the new stock, an amount equal to that which it had paid as a cash dividend to the stockholder.

Both of these methods of retaining accumulated profits while in effect distributing them as a dividend had been in common use in the United States for many years prior to the adoption of the Sixteenth Amendment. They were recognized equivalents. Whether a particular corporation employed one or the other method was determined sometimes by requirements of the law under which the corporation was organized; sometimes it was determined by preferences of the individual officials of the corporation, and sometimes by stock market conditions. Whichever method was employed, the resultant distribution of the new stock was commonly referred to as a stock dividend. How these two methods have been employed may be illustrated by the action in this respect (as reported in Moody's Manual, 1918 Industrial, and the Commercial and Financial Chronicle) of some of the Standard Oil companies since the disintegration pursuant to the decision of this Court in 1911. Standard Oil Co. v. United States, 221 U. S. 1.

(a) Standard Oil Co. (of Indiana), an Indiana corporation. It had on December 31, 1911, $1,000,000 capital stock (all common), and a large surplus. On May 15,

Page 252 U. S. 222

1912, it increased its capital stock to $30,000,000, and paid a simple stock dividend of 2,900 percent in stock. [Footnote 1]

(b) Standard Oil Co. (of Nebraska), a Nebraska corporation. It had on December 31, 1911, $600,000 capital stock (all common), and a substantial surplus. On April 15, 1912, it paid a simple stock dividend of 33 1/3 percent, increasing the outstanding capital to $800,000. During the calendar year 1912, it paid cash dividends aggregating 20 percent, but it earned considerably more, and had at the close of the year again a substantial surplus. On June 20, 1913, it declared a further stock dividend of 25 percent, thus increasing the capital to $1,000,000. [Footnote 2]

(c) The Standard Oil Co. (of Kentucky), a Kentucky corporation. It had on December 31, 1913, $1,000,000 capital stock (all common) and $3,701,710 surplus. Of this surplus, $902,457 had been earned during the calendar year 1913, the net profits of that year having been $1,002,457 and the dividends paid only $100,000 (10 percent). On December 22, 1913, a cash dividend of $200 per share was declared payable on February 14, 1914, to stockholders of record January 31, 1914, and these stockholders were offered the right to subscribe for an equal amount of new stock at par and to apply the cash dividend in payment therefor. The outstanding stock was thus increased to $3,000,000. During the calendar years 1914, 1915, and 1916, quarterly dividends were paid on this stock at an annual rate of between 15 percent and 20 percent, but the company's surplus increased by $2,347,614, so that, on December 31, 1916, it had a large surplus over its $3,000,000 capital stock. On December 15, 1916, the company issued a circular to the stockholders, saying:

"The company's business for this year has shown a

Page 252 U. S. 223

very good increase in volume and a proportionate increase in profits, and it is estimated that, by January 1, 1917, the company will have a surplus of over $4,000,000. The board feels justified in stating that, if the proposition to increase the capital stock is acted on favorably, it will be proper in the near future to declare a cash dividend of 100 percent and to allow the stockholders the privilege pro rata according to their holdings, to purchase the new stock at par, the plan being to allow the stockholders, if they desire, to use their cash dividend to pay for the new stock."

The increase of stock was voted. The company then paid a cash dividend of 100 percent, payable May 1, 1917, again offering to such stockholders the right to subscribe for an equal amount of new stock at par and to apply the cash dividend in payment therefor.

Moody's Manual, describing the transaction with exactness, says first that the stock was increased from $3,000,000 to $6,000,000, "a cash dividend of 100 percent, payable May 1, 1917, being exchanged for one share of new stock, the equivalent of a 100 percent stock dividend." But later in the report giving, as customary in the Manual, the dividend record of the company, the Manual says: "A stock dividend of 200 percent was paid February 14, 1914, and one of 100 percent on May 1, 1197." And, in reporting specifically the income account of the company for a series of years ending December 31, covering net profits, dividends paid, and

surplus for the year, it gives, as the aggregate of dividends for the year 1917, $660,000 (which was the aggregate paid on the quarterly cash dividend -- 5 percent January and April; 6 percent July and October), and adds in a note: "In addition, a stock dividend of 100 percent was paid during the year." [Footnote 3] The Wall Street Journal of

Page 252 U. S. 224

May 2, 1917, p. 2, quotes the 1917 "high" price for Standard Oil of Kentucky as "375 ex stock dividend."

It thus appears that, among financiers and investors, the distribution of the stock, by whichever method effected, is called a stock dividend; that the two methods by which accumulated profits are legally retained for corporate purposes and at the same time distributed as dividends are recognized by them to be equivalents, and that the financial results to the corporation and to the stockholders of the two methods are substantially the same, unless a difference results from the application of the federal income tax law.

Mrs. Macomber, a citizen and resident of New York, was, in the year 1916, a stockholder in the Standard Oil Company (of California), a corporation organized under the laws of California and having its principal place of business in that state. During that year, she received from the company a stock dividend representing profits earned since March 1, 1913. The dividend was paid by direct issue of the stock to her according to the simple method described above, pursued also by the Indiana and Nebraska companies. In 1917, she was taxed under the federal law on the stock dividend so received at its par value of $100 a share, as income received during the year 1916. Such a stock dividend is income, as distinguished from capital, both under the law of New York and under the law of California, because in both states every dividend representing profits is deemed to be income, whether paid in cash or in stock. It had been so held in New York, where the question arose as between life tenant and remainderman, Lowry v. Farmers' Loan & Trust Co., 172 N.Y. 137; Matter of Osborne, 209 N.Y. 450, and also, where the question arose in matters of taxation, People v. Glynn,

Page 252 U. S. 225

130 App.Div. 332, 198 N.Y. 605. It has been so held in California, where the question appears to have arisen only in controversies between life tenant and remainderman. Estate of Duffill, 58 Cal.Dec. 97, 180 Cal. 748.

It is conceded that, if the stock dividend paid to Mrs. Macomber had been made by the more complicated method pursued by the Standard Oil Company of Kentucky -- that is, issuing rights to take new stock pro rata and paying to each stockholder simultaneously a dividend in cash sufficient in amount to enable him to pay for this pro rata of new stock to be purchased -- the dividend so paid to him would have been taxable as income, whether he retained the cash or whether he returned it to the corporation in payment for his pro rata of new stock. But it is contended that, because the simple method was adopted of having the new stock issued direct

to the stockholders as paid-up stock, the new stock is not to be deemed income, whether she

retained it or converted it into cash by sale. If such a different result can flow merely from the difference in the method pursued, it must be because Congress is without power to tax as income of the stockholder either the stock received under the latter method or the proceeds of its sale, for Congress has, by the provisions in the Revenue Act of 1916, expressly declared its purpose to make stock dividends, by whichever method paid, taxable as income.

The Sixteenth Amendment, proclaimed February 25, 1913, declares:

"The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration."

The Revenue Act of September 8, 1916, c. 463, § 2a, 39 Stat. 756, 757, provided:

"That the term 'dividends' as used in this title shall

Page 252 U. S. 226

be held to mean any distribution made or ordered to be made by a corporation,

earnings or profits accrued since March first, nineteen hundred and thirteen, and payable to its

shareholders, whether in cash or in stock of the corporation, considered income, to the amount of its cash value."

out of its

which stock dividend shall be

Hitherto, powers conferred upon Congress by the Constitution have been liberally construed, and have been held to extend to every means appropriate to attain the end sought. In determining the scope of the power, the substance of the transaction, not its form, has been regarded. Martin v. Hunter, 1 Wheat. 304, 14 U. S. 326; McCulloch v. Maryland, 4 Wheat. 316, 17 U. S. 407, 17 U. S. 415; Brown v. Maryland, 12 Wheat. 419, 25 U. S. 446; Craig v. Missouri, 4 Pet. 410, 29 U. S. 433; Jarrolt v. Moberly, 103 U. S. 580, 103 U. S. 585-587; Legal Tender Case, 110 U. S. 421, 110 U. S. 444; Lithograph Co. v. Sarony,111 U. S. 53, 111 U. S. 58; United States v. Realty Co., 163 U. S. 427, 163 U. S. 440-442; South Carolina v. United States, 199 U. S. 437, 199 U. S. 448-449. Is there anything in the phraseology of the Sixteenth Amendment or in the nature of corporate dividends which should lead to a departure from these rules of construction and compel this Court to hold that Congress is powerless to prevent a result so extraordinary as that here contended for by the stockholder?

First. The term "income," when applied to the investment of the stockholder in a corporation, had, before the adoption of the Sixteenth Amendment, been commonly understood to mean the

returns from time to time received by the stockholder from gains or earnings of the corporation.

A dividend received by a stockholder from a corporation may be either in distribution of capital

assets or in distribution of profits. Whether it is the one or the other is in no way affected by the medium in which it is paid, nor by the method or means through which the particular thing distributed as a dividend was procured. If the

Page 252 U. S. 227

dividend is declared payable in cash, the money with which to pay it is ordinarily taken from surplus cash in the treasury. But (if there are profits legally available for distribution and the law under which the company was incorporated so permits) the company may raise the money by discounting negotiable paper, or by selling bonds, scrip or stock of another corporation then in the treasury, or by selling its own bonds, scrip or stock then in the treasury, or by selling its own bonds, scrip or stock issued expressly for that purpose. How the money shall be raised is wholly a matter of financial management. The manner in which it is raised in no way affects the question whether the dividend received by the stockholder is income or capital, nor can it conceivably affect the question whether it is taxable as income.

Likewise whether a dividend declared payable from profits shall be paid in cash or in some other medium is also wholly a matter of financial management. If some other medium is decided upon, it is also wholly a question of financial management whether the distribution shall be, for instance, in bonds, scrip or stock of another corporation or in issues of its own. And if the dividend is paid in its own issues, why should there be a difference in result dependent upon whether the distribution was made from such securities then in the treasury or from others to be created and issued by the company expressly for that purpose? So far as the distribution may be made from its own issues of bonds, or preferred stock created expressly for the purpose, it clearly would make no difference, in the decision of the question whether the dividend was a distribution of profits, that the securities had to be created expressly for the purpose of distribution. If a dividend paid in securities of that nature represents a distribution of profits, Congress may, of course, tax it as income of the stockholder. Is the result different where the security distributed is common stock?

Page 252 U. S. 228

Suppose that a corporation having power to buy and sell its own stock purchases, in the interval between its regular dividend dates, with moneys derived from current profits, some of its own common stock as a temporary investment, intending at the time of purchase to sell it before the next dividend date and to use the proceeds in paying dividends, but later, deeming it inadvisable either to sell this stock or to raise by borrowing the money necessary to pay the regular dividend in cash, declares a dividend payable in this stock; can anyone doubt that, in such a case, the dividend in common stock would be income of the stockholder and constitutionally taxable as such? See Green v. Bissell, 79 Conn. 547; Leland v. Hayden, 102 Mass. 542. And would it not likewise be income of the stockholder subject to taxation if the purpose of the company in buying the stock so distributed had been from the beginning to take it off the market and distribute it among the stockholders as a dividend, and the company actually did so? And, proceeding a short step further, suppose that a corporation decided to capitalize some of its accumulated profits by creating additional common stock and selling the same to raise working capital, but after the stock has been issued and certificates therefor are delivered to the bankers for sale, general financial conditions make it undesirable to market the stock, and the company concludes that it is wiser to husband, for working capital, the cash which it had intended to use

in paying stockholders a dividend, and, instead, to pay the dividend in the common stock which it had planned to sell; would not the stock so distributed be a distribution of profits, and hence, when received, be income of the stockholder and taxable as such? If this be conceded, why should it not be equally income of the stockholder, and taxable as such, if the common stock created by capitalizing profits had been originally created for the express purpose of being distributed

Page 252 U. S. 229

as a dividend to the stockholder who afterwards received it?

Second. It has been said that a dividend payable in bonds or preferred stock created for the purpose of distributing profits may be income and taxable as such, but that the case is different where the distribution is in common stock created for that purpose. Various reasons are assigned for making this distinction. One is that the proportion of the stockholder's ownership to the aggregate number of the shares of the company is not changed by the distribution. But that is equally true where the dividend is paid in its bonds or in its preferred stock. Furthermore, neither maintenance nor change in the proportionate ownership of a stockholder in a corporation has any bearing upon the question here involved. Another reason assigned is that the value of the old stock held is reduced approximately by the value of the new stock received, so that the stockholder, after receipt of the stock dividend, has no more than he had before it was paid. That is equally true whether the dividend be paid in cash or in other property -- for instance, bonds, scrip, or preferred stock of the company. The payment from profits of a large cash dividend, and even a small one, customarily lowers the then market value of stock because the undivided property represented by each share has been correspondingly reduced. The argument which appears to be most strongly urged for the stockholders is that, when a stock dividend is made, no portion of the assets of the company is thereby segregated for the stockholder. But does the issue of new bonds or of preferred stock created for use as a dividend result in any segregation of assets for the stockholder? In each case, he receives a piece of paper which entitles him to certain rights in the undivided property. Clearly, segregation of assets in a physical sense is not an essential of income. The year's gains of a partner is taxable as income although there likewise no

Page 252 U. S. 230

segregation of his share in the gains from that of his partners is had.

The objection that there has been no segregation is presented also in another form. It is argued that, until there is a segregation, the stockholder cannot know whether he has really received gains, since the gains may be invested in plant or merchandise or other property, and perhaps be later lost. But is not this equally true of the share of a partner in the year's profits of the firm or, indeed, of the profits of the individual who is engaged in business alone? And is it not true also when dividends are paid in cash? The gains of a business, whether conducted by an individual, by a firm, or by a corporation are ordinarily reinvested in large part. Many a cash

dividend honestly declared as a distribution of profits proves later to have been paid out of capital because errors in forecast prevent correct ascertainment of values. Until a business adventure has been completely liquidated, it can never be determined with certainty whether there have been profits unless the returns at least exceeded the capital originally invested. Businessmen, dealing with the problem practically, fix necessarily periods and rules for determining whether there have been net profits -- that is, income or gains. They protect themselves from being seriously misled by adopting a system of depreciation charges and reserves. Then they act upon their own determination whether profits have been made. Congress, in legislating, has wisely adopted their practices as its own rules of action.

Third. The government urges that it would have been within the power of Congress to have taxed as income of the stockholder his pro rata share of undistributed profits earned even if no stock dividend representing it had been paid. Strong reasons may be assigned for such a view. See Collector v. Hubbard, 12 Wall. 1. The undivided share of a partner in the year's undistributed profits of his firm

Page 252 U. S. 231

is taxable as income of the partner although the share in the gain is not evidenced by any action

taken by the firm. Why may not the stockholder's interest in the gains of the company? The law finds no difficulty in disregarding the corporate fiction whenever that is deemed necessary to attain a just result. Linn Timber Co. v. United States, 236 U. S. 574. See Morawetz on Corporations, 2d ed., §§ 227-231; Cook on Corporations, 7th ed., §§ 663, 664. The stockholder's interest in the property of the corporation differs not fundamentally, but in form only, from the interest of a partner in the property of the firm. There is much authority for the proposition that, under our law, a partnership or joint stock company is just as distinct and

palpable an entity in the idea of the law, as distinguished from the individuals composing it, as is

a corporations. [Footnote 4] No reason appears, why Congress, in legislating under a grant of

power so comprehensive as that authorizing the levy of an income tax, should be limited by the particular view of the relation of the stockholder to the corporation and its property which may, in the absence of legislation, have been taken by this Court. But we have no occasion to decide

the question whether Congress might have taxed to the stockholder his undivided share of the corporation's earnings. For Congress has in this act limited the income tax to that share of the stockholder in the earnings which is, in effect, distributed by means of the stock dividend paid. In other words, to render the stockholder taxable, there must be both earnings made and a dividend paid. Neither earnings without dividend nor a dividend without earnings subjects the

Page 252 U. S. 232

stockholder to taxation under the Revenue Act of 1916.

Fourth. The equivalency of all dividends representing profits, whether paid of all dividends in stock, is so complete that serious question of the taxability of stock dividends would probably never have been made if Congress had undertaken to tax only those dividends which

represented profits earned during the year in which the dividend was paid or in the year preceding. But this Court, construing liberally not only the constitutional grant of power but also the revenue Act of 1913, held that Congress might tax, and had taxed, to the stockholder dividends received during the year, although earned by the company long before, and even prior to the adoption of the Sixteenth Amendment. Lynch v. Hornby, 247 U. S. 339. [Footnote 5] That rule, if indiscriminatingly applied to all stock dividends representing profits earned, might, in view of corporate practice, have worked considerable hardship and have raised serious questions. Many corporations, without legally capitalizing any part of their profits, had assigned definitely some part or all of the annual balances remaining after paying the usual cash dividends to the uses to which permanent capital is ordinarily applied. Some of the corporations doing this transferred such balances on their books to "surplus" account -- distinguishing between such permanent "surplus" and the "undivided profits" account. Other corporations, without this formality, had assumed that the annual accumulating balances carried as undistributed profits were to be treated as capital permanently invested in the business. And still others, without definite assumption of any kind, had

Page 252 U. S. 233

so used undivided profits for capital purposes. To have made the revenue law apply retroactively so as to reach such accumulated profits, if and whenever it should be deemed desirable to capitalize them legally by the issue of additional stock distributed as a dividend to stockholders, would have worked great injustice. Congress endeavored in the Revenue Act of 1916 to guard against any serious hardship which might otherwise have arisen from making taxable stock dividends representing accumulated profits. It did not limit the taxability to stock dividends representing profits earned within the tax year or in the year preceding, but it did limit taxability to such dividends representing profits earned since March 1, 1913. Thereby stockholders were given notice that their share also in undistributed profits accumulating thereafter was at some time to be taxed as income. And Congress sought by § 3 to discourage the postponement of distribution for the illegitimate purpose of evading liability to surtaxes.

Fifth. The decision of this Court that earnings made before the adoption of the Sixteenth Amendment, but paid out in cash dividend after its adoption, were taxable as income of the stockholder involved a very liberal construction of the amendment. To hold now that earnings both made and paid out after the adoption of the Sixteenth Amendment cannot be taxed as income of the stockholder, if paid in the form of a stock dividend, involves an exceedingly narrow construction of it. As said by Mr. Chief Justice Marshall in Brown v. Maryland, 12 Wheat. 419, 25 U. S. 446:

"To construe the power so as to impair its efficacy would tend to defeat an object in the attainment of which the American public took, and justly took, that strong interest which arose from a full conviction of its necessity."

No decision heretofore rendered by this Court requires us to hold that Congress, in providing for the taxation of

Page 252 U. S. 234

stock dividends, exceeded the power conferred upon it by the Sixteenth Amendment. The two cases mainly relied upon to show that this was beyond the power of Congress are Towne v. Eisner, 245 U. S. 418, which involved a question not of constitutional power, but of statutory construction, and Gibbons v. Mahon, 136 U. S. 549, which involved a question arising between life tenant and remainderman. So far as concerns Towne v. Eisner, we have only to bear in mind what was there said (p. 245 U. S. 425): "But it is not necessarily true that income means the same thing in the Constitution and the [an] act." [Footnote 6] Gibbons v. Mahon is even less an authority for a narrow construction of the power to tax incomes conferred by the Sixteenth Amendment. In that case, the court was required to determine how, in the administration of an estate in the District of Columbia, a stock dividend, representing profits, received after the decedent's death, should be disposed of as between life tenant and remainderman. The question was, in essence, what shall the intention of the testator be presumed to have been? On this question, there was great diversity of opinion and practice in the courts of English- speaking countries. Three well defined rules were then competing for acceptance. Two of these involves an arbitrary rule of distribution, the third equitable apportionment. See Cook on Corporations, 7th ed., §§ 552-558.

1. The so-called English rule, declared in 1799 by Brander v. Brander, 4 Ves. Jr. 800, that a

dividend representing

Page 252 U. S. 235

profits, whether in cash, stock or other property, belongs to the life tenant if it was a regular or ordinary dividend, and belongs to the remainderman if it was an extraordinary dividend.

2. The so-called Massachusetts rule, declared in 1868 by Minot v. Paine, 99 Mass. 101, that a

dividend representing profits, whether regular, ordinary, or extraordinary, if in cash belongs to the life tenant, and if in stock belongs to the remainderman.

3. The so-called Pennsylvania rule, declared in 1857 by Earp's Appeal, 28 Pa. 368, that, where

a stock dividend is paid, the court shall inquire into the circumstances under which the fund had been earned and accumulated out of which the dividend, whether a regular, an ordinary, or an extraordinary one, was paid. If it finds that the stock dividend was paid out of profits earned since the decedent's death, the stock dividend belongs to the life tenant; if the court finds that the stock dividend was paid from capital or from profits earned before the decedent's death, the stock dividend belongs to the remainderman.

This Court adopted in Gibbons v. Mahon as the rule of administration for the District of Columbia the so-called Massachusetts rule, the opinion being delivered in 1890 by Mr. Justice Gray. Since then, the same question has come up for decision in many of the states. The so- called Massachusetts rule, although approved by this Court, has found favor in only a few states. The so-called Pennsylvania rule, on the other hand, has been adopted since by so many

of the states (including New York and California) that it has come to be known as the "American rule." Whether, in view of these facts and the practical results of the operation of the two rules as shown by the experience of the 30 years which have elapsed since the decision in Gibbons v. Mahon, it might be desirable for this Court to reconsider the question there decided, as

Page 252 U. S. 236

some other courts have done (see 29 Harvard Law Review 551), we have no occasion to consider in this case. For, as this Court there pointed out (p. 136 U. S. 560), the question involved was one "between the owners of successive interests in particular shares," and not, as in Bailey v. Railroad Co., 22 Wall. 604, a question

"between the corporation and the government, and [which] depended upon the terms of a statute carefully framed to prevent corporations from evading payment of the tax upon their earnings."

We have, however, not merely argument; we have examples which should convince us that "there is no inherent, necessary and immutable reason why stock dividends should always be treated as capital." Tax Commissioner v. Putnam, 227 Mass. 522, 533. The Supreme Judicial Court of Massachusetts has steadfastly adhered, despite ever-renewed protest, to the rule that every stock dividend is, as between life tenant and remainderman, capital, and not income. But, in construing the Massachusetts Income Tax Amendment, which is substantially identical with the federal amendment, that court held that the legislature was thereby empowered to levy an income tax upon stock dividends representing profits. The courts of England have, with some relaxation, adhered to their rule that every extraordinary dividend is, as between life tenant and remainderman, to be deemed capital. But, in 1913, the Judicial Committee of the Privy Council held that a stock dividend representing accumulated profits was taxable like an ordinary cash dividend, Swan Brewery Co., Ltd. v. Rex, [1914] A.C. 231. In dismissing the appeal, these words of the Chief Justice of the Supreme Court of Western Australia were quoted (p. 236), which show that the facts involved were identical with those in the case at bar:

"Had the company distributed the 101,450 among the shareholders, and had the shareholders repaid such sums to the company as the price of the 81, 160 new shares, the duty on the 101,450

Page 252 U. S. 237

would clearly have been payable. Is not this virtually the effect of what was actually done? I think it is."

Sixth. If stock dividends representing profits are held exempt from taxation under the Sixteenth Amendment, the owners of the most successful businesses in America will, as the facts in this case illustrate, be able to escape taxation on a large part of what is actually their income. So far as their profits are represented by stock received as dividends, they will pay these taxes not

upon their income, but only upon the income of their income. That such a result was intended by the people of the United States when adopting the Sixteenth Amendment is inconceivable. Our sole duty is to ascertain their intent as therein expressed. [Footnote 7] In terse, comprehensive language befitting the Constitution, they empowered Congress "to lay and collect taxes on incomes from whatever source derived." They intended to include thereby everything which by reasonable understanding can fairly be regarded as income. That stock dividends representing profits are so regarded not only by the plain people, but by investors and financiers and by most of the courts of the country, is shown beyond peradventure by their acts and by their utterances. It seems to me clear, therefore, that Congress possesses the power which it exercised to make dividends representing profits taxable as income whether the medium in which the dividend is paid be cash or stock, and that it may define, as it has done, what dividends representing

Page 252 U. S. 238

profits shall be deemed income. It surely is not clear that the enactment exceeds the power granted by the Sixteenth Amendment. And, as this Court has so often said, the high prerogative of declaring an act of Congress invalid should never be exercised except in a clear case. [Footnote 8]

"It is but a decent respect due to the wisdom, the integrity, and the patriotism of the legislative body by which any law is passed to presume in favor of its validity until its violation of the Constitution is proved beyond all reasonable doubt."

CLAIM OF RIGHT DOCTRINE

COMMISSIONER V TOURS SPECIALIST

29JAN

183 SCRA 402 | March 21, 1990 | J. Gutierrez, Jr.

Gross receipts subject to tax under the Tax Code do not include monies or receipts entrusted to the taxpayer which do not belong to them and do not redound to the taxpayer’s benefit; and it is not necessary that there must be a law or regulation which would exempt such monies or receipts within the meaning of gross receipts under the Tax Code Facts:

The Commissioner of Internal Revenue filed a petition to review on certiorari to the CTA decision which ruled that the money entrusted to private respondent Tours Specialist (TS), earmarked and paid for hotel room charges of tourists, travellers and/or foreign travel agencies do not form part of its gross receipt subject to 3% independent contractor’s tax.

Tours Specialist derived income from its activities and services as a travel agency, which included booking tourists in local hotels. To supply such service, TS and its counterpart tourist agencies abroad have agreed to offer a package fee for the tourists (payment of hotel room accommodations, food and other personal expenses). By arrangement, the foreign tour agency entrusts to TS the fund for hotel room accommodation, which in turn paid by the latter to the local hotel when billed.

Despite this arrangement, CIR assessed private respondent for deficiency 3% contractor’s tax as independent contractor including the entrusted hotel room charges in its gross receipts from services for years 1974-1976 plus compromise penalty.

During cross-examination, TS General Manager stated that the payment through them “is only an act of accommodation on (its) part” and “the agent abroad instead of sending several telexes and saving on bank charges they take the option to send the money to (TS) to be held in trust to be endorsed to the hotel.”’

Nevertheless, CIR caused the issuance of a warrant of distraint and levy, and had TS’ bank deposits garnished.

Issue:

W/N amounts received by a local tourist and travel agency included in a package fee from tourists or foreign tour agencies, intended or earmarked for hotel accommodations form part of gross receipts subject to 3% contractor’s tax

Held:

No. Gross receipts subject to tax under the Tax Code do not include monies or receipts entrusted to the taxpayer which do not belong to them and do not redound to the taxpayer’s benefit; and it is not necessary that there must be a law or regulation which would exempt such monies or receipts within the meaning of gross receipts under the Tax Code. Parenthetically, the room charges entrusted by the foreign travel agencies to the private respondents do not form part of its gross receipts within the definition of the Tax Code. The said receipts never belonged to the private respondent. The private respondent never benefited from their payment to the local hotels. This arrangement was only to accommodate the foreign travel agencies.

Republic of the Philippines SUPREME COURT Manila

G.R. No. 78953 July 31, 1991

SECOND DIVISION

COMMISSIONER OF INTERNAL REVENUE, petitioner, vs. MELCHOR J. JAVIER, JR. and THE COURT OF TAX APPEALS, respondents.

Elison G. Natividad for accused-appellant.

SARMIENTO, J.:p

Central in this controversy is the issue as to whether or not a taxpayer who merely states as a footnote in his income tax return that a sum of money that he erroneously received and already spent is the subject of a pending litigation and there did not declare it as income is liable to pay the 50% penalty for filing a fraudulent return.

This question is the subject of the petition for review before the Court of the portion of the Decision 1 dated July 27, 1983 of the Court of Tax Appeals (CTA) in C.T.A. Case No. 3393, entitled, "Melchor J. Javier, Jr. vs. Ruben B. Ancheta, in his capacity as Commissioner of Internal Revenue," which orders the deletion of the 50% surcharge from Javier's deficiency income tax assessment on his income for 1977.

The respondent CTA in a Resolution 2 dated May 25, 1987, denied the Commissioner's Motion for Reconsideration 3 and Motion for New Trial 4 on the deletion of the 50% surcharge assessment or imposition.

The pertinent facts as are accurately stated in the petition of private respondent Javier in the CTA and incorporated in the assailed decision now under review, read as follows:

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2. That on or about June 3, 1977, Victoria L. Javier, the wife of the petitioner (private respondent herein), received from the Prudential Bank and Trust Company in Pasay City the amount of US$999,973.70 remitted by her sister, Mrs. Dolores Ventosa, through some banks in the United States, among which is Mellon Bank, N.A.

3.

That on or about June 29, 1977, Mellon Bank, N.A. filed a complaint with the

Court of First Instance of Rizal (now Regional Trial Court), (docketed as Civil Case No. 26899), against the petitioner (private respondent herein), his wife and other defendants, claiming that its remittance of US$1,000,000.00 was a clerical error and should have been US$1,000.00 only, and praying that the excess amount of US$999,000.00 be returned on the ground that the defendants are trustees of an implied trust for the benefit of Mellon Bank with the clear, immediate, and continuing duty to return the said amount from the moment it was received.

4. That on or about November 5, 1977, the City Fiscal of Pasay City filed an

Information with the then Circuit Criminal Court (docketed as CCC-VII-3369-P.C.) charging the petitioner (private respondent herein) and his wife with the crime of estafa, alleging that they misappropriated, misapplied, and converted to their own personal use and benefit the amount of US$999,000.00 which they received under an implied trust for the benefit of Mellon Bank and as a result of the mistake in the remittance by the latter.

5. That on March 15, 1978, the petitioner (private respondent herein) filed his

Income Tax Return for the taxable year 1977 showing a gross income of P53,053.38 and a net income of P48,053.88 and stating in the footnote of the return that "Taxpayer was recipient of some money received from abroad which he presumed to be a gift but turned out to be an error and is now subject of litigation."

6. That on or before December 15, 1980, the petitioner (private respondent

herein) received a letter from the acting Commissioner of Internal Revenue dated November 14, 1980, together with income assessment notices for the years 1976 and 1977, demanding that petitioner (private respondent herein) pay on or before December 15, 1980 the amount of P1,615.96 and P9,287,297.51 as deficiency assessments for the years 1976 and 1977

7. That on December 15, 1980, the petitioner (private respondent herein) wrote

the Bureau of Internal Revenue that he was paying the deficiency income assessment for the year 1976 but denying that he had any undeclared income for the year 1977 and requested that the assessment for 1977 be made to await final court decision on the case filed against him for filing an allegedly fraudulent

8. That on November 11, 1981, the petitioner (private respondent herein)

received from Acting Commissioner of Internal Revenue Romulo Villa a letter dated October 8, 1981 stating in reply to his December 15, 1980 letter-protest that "the amount of Mellon Bank's erroneous remittance which you were able to dispose, is definitely taxable."

5

The Commissioner also imposed a 50% fraud penalty against Javier.

Disagreeing, Javier filed an appeal 6 before the respondent Court of Tax Appeals on December 10, 1981.

The respondent CTA, after the proper proceedings, rendered the challenged decision. We quote the concluding portion:

We note that in the deficiency income tax assessment under consideration, respondent (petitioner here) further requested petitioner (private respondent here) to pay 50% surcharge as provided for in Section 72 of the Tax Code, in addition to the deficiency income tax of P4,888,615.00 and interest due thereon. Since petitioner (private respondent) filed his income tax return for taxable year 1977, the 50% surcharge was imposed, in all probability, by respondent (petitioner) because he considered the return filed false or fraudulent. This additional requirement, to our mind, is much less called for because petitioner (private respondent), as stated earlier, reflected in as 1977 return as footnote that "Taxpayer was recipient of some money received from abroad which he presumed to be gift but turned out to be an error and is now subject of litigation."

From this, it can hardly be said that there was actual and intentional fraud, consisting of deception willfully and deliberately done or resorted to by petitioner (private respondent) in order to induce the Government to give up some legal right, or the latter, due to a false return, was placed at a disadvantage so as to prevent its lawful agents from proper assessment of tax liabilities. (Aznar vs. Court of Tax Appeals, L-20569, August 23, 1974, 56 (sic) SCRA 519), because petitioner literally "laid his cards on the table" for respondent to examine. Error or mistake of fact or law is not fraud. (Insular Lumber vs. Collector, L-7100, April 28, 1956.). Besides, Section 29 is not too plain and simple to understand. Since the question involved in this case is of first impression in this jurisdiction, under the circumstances, the 50% surcharge imposed in the deficiency assessment should be deleted. 7

The Commissioner of Internal Revenue, not satisfied with the respondent CTA's ruling, elevated the matter to us, by the present petition, raising the main issue as to:

WHETHER OR NOT PRIVATE RESPONDENT IS LIABLE FOR THE 50% FRAUD PENALTY? 8

On the other hand, Javier candidly stated in his Memorandum, 9 that he "did not appeal the decision which held him liable for the basic deficiency income tax (excluding the 50% surcharge for fraud)." However, he submitted in the same memorandum "that the issue may be raised in the case not for the purpose of correcting or setting aside the decision which held him liable for deficiency income tax, but only to show that there is no basis for the imposition of the

surcharge." This subsequent disavowal therefore renders moot and academic the posturings articulated in as Comment 10 on the non-taxability of the amount he erroneously received and the bulk of which he had already disbursed. In any event, an appeal at that time (of the filing of the Comments) would have been already too late to be seasonable. The petitioner, through the office of the Solicitor General, stresses that:

xxx xxx xxx

The record however is not ambivalent, as the record clearly shows that private respondent is self-convinced, and so acted, that he is the beneficial owner, and of which reason is liable to tax. Put another way, the studied insinuation that private respondent may not be the beneficial owner of the money or income flowing to him as enhanced by the studied claim that the amount is "subject of litigation" is belied by the record and clearly exposed as a fraudulent ploy, as witness what transpired upon receipt of the amount.

Here, it will be noted that the excess in the amount erroneously remitted by MELLON BANK for the amount of private respondent's wife was $999,000.00 after opening a dollar account with Prudential Bank in the amount of $999,993.70, private respondent and his wife, with haste and dispatch, within a span of eleven (11) electric days, specifically from June 3 to June 14, 1977, effected a total massive withdrawal from the said dollar account in the sum of $975,000.00 or

11

In reply, the private respondent argues:

xxx xxx xxx

The petitioner contends that the private respondent committed fraud by not declaring the "mistaken remittance" in his income tax return and by merely making a footnote thereon which read: "Taxpayer was the recipient of some money from abroad which he presumed to be a gift but turned out to be an error and is now subject of litigation." It is respectfully submitted that the said return was not fraudulent. The footnote was practically an invitation to the petitioner to make an investigation, and to make the proper assessment.

The rule in fraud cases is that the proof "must be clear and convincing" (Griffiths v. Comm., 50 F [2d] 782), that is, it must be stronger than the "mere preponderance of evidence" which would be sufficient to sustain a judgment on the issue of correctness of the deficiency itself apart from the fraud penalty. (Frank A. Neddas, 40 BTA 672). The following circumstances attendant to the case at bar show that in filing the questioned return, the private respondent was guided, not by that "willful and deliberate intent to prevent the Government from

making a proper assessment" which constitute fraud, but by an honest doubt as to whether or not the "mistaken remittance" was subject to tax.

First, this Honorable Court will take judicial notice of the fact that so-called "million dollar case" was given very, very wide publicity by media; and only one who is not in his right mind would have entertained the idea that the BIR would not make an assessment if the amount in question was indeed subject to the income tax.

Second, as the respondent Court ruled, "the question involved in this case is of first impression in this jurisdiction" (See p. 15 of Annex "A" of the Petition). Even in the United States, the authorities are not unanimous in holding that similar receipts are subject to the income tax. It should be noted that the decision in the Rutkin case is a five-to-four decision; and in the very case before this Honorable Court, one out of three Judges of the respondent Court was of the opinion that the amount in question is not taxable. Thus, even without the footnote, the failure to declare the "mistaken remittance" is not fraudulent.

Third, when the private respondent filed his income tax return on March 15, 1978 he was being sued by the Mellon Bank for the return of the money, and was being prosecuted by the Government for estafa committed allegedly by his failure to return the money and by converting it to his personal benefit. The basic tax amounted to P4,899,377.00 (See p. 6 of the Petition) and could not have been paid without using part of the mistaken remittance. Thus, it was not unreasonable for the private respondent to simply state in his income tax return that the amount received was still under litigation. If he had paid the tax, would that not constitute estafa for using the funds for his own personal benefit? and would the Government refund it to him if the courts ordered him to refund the money to the Mellon Bank? 12

xxx xxx xxx

Under the then Section 72 of the Tax Code (now Section 248 of the 1988 National Internal Revenue Code), a taxpayer who files a false return is liable to pay the fraud penalty of 50% of the tax due from him or of the deficiency tax in case payment has been made on the basis of the return filed before the discovery of the falsity or fraud.

We are persuaded considerably by the private respondent's contention that there is no fraud in the filing of the return and agree fully with the Court of Tax Appeals' interpretation of Javier's notation on his income tax return filed on March 15, 1978 thus: "Taxpayer was the recipient of some money from abroad which he presumed to be a gift but turned out to be an error and is now subject of litigation that it was an "error or mistake of fact or law" not constituting fraud, that such notation was practically an invitation for investigation and that Javier had literally "laid his cards on the table." 13

In Aznar v. Court of Tax Appeals, 14 fraud in relation to the filing of income tax return was discussed in this manner:

The fraud contemplated by law is actual and not constructive. It must be intentional fraud, consisting of deception willfully and deliberately done or resorted to in order to induce another to give up some legal right. Negligence, whether slight or gross, is not equivalent to the fraud with intent to evade the tax contemplated by law. It must amount to intentional wrong-doing with the sole object of avoiding the tax. It necessarily follows that a mere mistake cannot be considered as fraudulent intent, and if both petitioner and respondent Commissioner of Internal Revenue committed mistakes in making entries in the returns and in the assessment, respectively, under the inventory method of determining tax liability, it would be unfair to treat the mistakes of the petitioner as tainted with fraud and those of the respondent as made in good faith.

Fraud is never imputed and the courts never sustain findings of fraud upon circumstances which, at most, create only suspicion and the mere understatement of a tax is not itself proof of fraud for the purpose of tax evasion. 15

A "fraudulent return" is always an attempt to evade a tax, but a merely "false return" may not be, Rick v. U.S., App. D.C., 161 F. 2d 897, 898. 16

In the case at bar, there was no actual and intentional fraud through willful and deliberate misleading of the government agency concerned, the Bureau of Internal Revenue, headed by the herein petitioner. The government was not induced to give up some legal right and place itself at a disadvantage so as to prevent its lawful agents from proper assessment of tax liabilities because Javier did not conceal anything. Error or mistake of law is not fraud. The petitioner's zealousness to collect taxes from the unearned windfall to Javier is highly commendable. Unfortunately, the imposition of the fraud penalty in this case is not justified by the extant facts. Javier may be guilty of swindling charges, perhaps even for greed by spending most of the money he received, but the records lack a clear showing of fraud committed because he did not conceal the fact that he had received an amount of money although it was a "subject of litigation." As ruled by respondent Court of Tax Appeals, the 50% surcharge imposed as fraud penalty by the petitioner against the private respondent in the deficiency assessment should be deleted.

WHEREFORE, the petition is DENIED and the decision appealed from the Court of Tax Appeals is AFFIRMED. No costs.

SO ORDERED.

INCOME FROM WHATEVER SOURCE

EN BANC

[G.R. Nos. L-9738 & L-9771. May 31, 1957.]

BLAS GUTIERREZ, and MARIA MORALES, Petitioners, v. HONORABLE COURT OF TAX APPEALS, and THE COLLECTOR OF INTERNAL REVENUE, Respondents.

COLLECTOR OF INTERNAL REVENUE, Petitioner, v. BLAS GUTIERREZ, MARIA MORALES, and COURT OF TAX APPEALS, Respondents.

Rafael Morales, for Petitioners.

Assistant Solicitor General Ramon L. Avanceña and Solicitor Jose P. Alejandro for Respondents.

SYLLABUS

1. EXPROPRIATION; INCOME FROM SOURCES WITHIN THE PHILIPPINES, WHERE

TAXABLE. — The compensation or income derived from the expropriation of property located in

the Philippines is an income from sources within the Philippines and subject to the taxing jurisdiction of the place.

2. ID.; ID.; TRANSFER OF PROPERTY EQUIVALENT TO SALE; PROCEEDS SUBJECT TO

INCOME TAX AS CAPITAL GAIN. — The acquisition by the Government of private properties through the exercise of the power of eminent domain, said properties being justly compensated, is embraced within the meaning of the term "sale" or "disposition of property," and the proceeds derived therefrom is subject to income tax as capital gain pursuant to the provisions of Section 37-(a)-(5) in relation to Section 29-(a) of the Tax Code.

3. ID.; ID.; ID.; ID.; INCOME NOT INCLUDED IN THE TAX EXEMPTIONS SPECIFIED IN THE

MILITARY BASES AGREEMENT. — The taxpayers maintain that since, at the request of the U. S. Government, the proceeding to expropriate the land in question necessary for the expansion of the Clark Field Air Base was instituted by the Philippine Government as part of its obligation under the Military Bases Agreement, the compensation accruing therefrom must necessarily fall under the exemption provided for by Section 29-(b)-6 of the Tax Code. This stand is untenable because while the condemnation or expropriation of properties wad provided for in the Agreement, the exemption from tax of the compensation to be paid for the expropriation of privately owned lands located in the Philippines was not given any attention, and the internal

revenue exemptions specifically taken care of by said agreement applies only to members of the U. S. Armed Forces serving in the Philippines and U. S. nationals working in these Islands in

connection with the construction, maintenance, operation and defense of said bases.

4. ID.; TRANSFER OF OWNERSHIP; WHEN TITLE PASSES TO EXPROPRIATOR. — In

condemnation proceedings, title to the land does not pass to the plaintiff until the indemnity is paid (Calvo v. Zandueta, 49 Phil. 605), and notwithstanding possession acquired by the expropriator, title does not actually pass to him until payment of the amount adjudged by the

Court and the registration of the judgment with the Register of Deeds (See Visayan Refining Company v. Camus Et. Al., 40 Phil. 550; Metropolitan Water District v. De los Angeles, 55 Phil.

783).

5. ID.; GAIN OR LOSS FROM SALE, HOW DETERMINED. — The property in question was

adjudicated to the owner by court order on March 23, 1929, and in accordance with Section 35 (b) of the Tax Code, only the fair market price or value of the property as of the date of the acquisition thereof should be considered in determining the gain or loss sustained by the property owner when the property was disposed, without taking into account the purchasing power of the currency used in the transaction. The value of the property at the time of its acquisition by the owner was P28,291.78 and the same was compensated with P94,305.75 when it was expropriated. The resulting difference is not merely nominal but a capital gain and should be correspondingly taxed.

6. TAXATION; ASSESSMENT MADE WITHIN THE PRESCRIPTIVE PERIOD, HOW

ENFORCED. — When the assessment for deficiency income tax was made by the Collector of Internal Revenue within the 3-year prescriptive period provided for by Section 51-d of the Tax Code, the same could be collected either by the administrative methods of distraint and levy or by judicial action.

7. COURT OF TAX APPEALS; REVIEW OF DECISIONS OF; ONLY QUESTIONS OF LAW

MAY BE CONSIDERED. — The question of fraud is a question of fact which is for the Court of Tax Appeals to determine. It is already settled in this jurisdiction that in passing upon petitions to review decisions of the Court of Tax Appeals, only questions of law may be considered.

D E C I S I O N

FELIX, J.:

Maria Morales was the registered owner of an agricultural land designated as Lot No. 724-C of the cadastral survey of Mabalacat, Pampanga. The Republic of the Philippines, at the request of the U.S. Government and pursuant to the terms of the Military Bases Agreement of March 14, 1947, instituted condemnation proceedings in the Court of First Instance of Pampanga, docketed as Civil Case No. 148, for the purpose of expropriating the lands owned by Maria Morales and others needed for the expansion of the Clark Field Air Base, which project is

necessary for the mutual protection and defense of the Philippines and the United States. Blas Gutiérrez was also made a party defendant in said Civil Case No. 148 for being the husband of the landowner Maria Morales. At the commencement of the action, the Republic of the Philippines, therein plaintiff, deposited with the Clerk of the Court of First Instance of Pampanga the sum of P156,960, which was provisionally fixed as the value of the lands sought to be expropriated, in order that it could take immediate possession of the same.

On January 27, 1949, upon order of the Court, the sum of P34,580 (PNB Check 721520-Exh. R) was paid by the Provincial Treasurer of Pampanga to Maria Morales out of the original deposit of P156,960 made by therein plaintiff. After due hearing, the Court of First Instance of Pampanga rendered decision dated November 29, 1949, wherein it fixed as just compensation P2,500 per hectare for some of the lots and P3,000 per hectare for the others, which values were based on the reports of the Commission on Appraisal whose members were chosen by both parties and by the Court, which took into consideration the different conditions affecting the value of the condemned properties in making their findings.

In virtue of said decision, defendant Maria Morales was to receive the amount of P94,305.75 as compensation for Lot No. 724-C which was one of the expropriated lands. But the Court disapproved defendants’ claims for consequential damages considering them amply compensated by the price awarded to their said properties. In order to avoid further litigation expenses and delay inherent to an appeal, the parties entered into a compromise agreement on January 7, 1950, modifying in part the decision rendered by the Court in the sense of fixing the compensation for all the lands, without distinction, at P2,500 per hectare, which compromise agreement was approved by the Court on January 9, 1950. This reduction of the price to P2,500 per hectare did not affect Lot No. 724-C of defendant Maria Morales. Sometime in 1950, the spouses Blas Gutiérrez and Maria Morales received the sum of P59,785.75 representing the balance remaining in their favor after deducting the amount of P34,580 already withdrawn from the compensation due to them.

In a notice of assessment dated January 28, 1953, the Collector of Internal Revenue demanded of the petitioners the payment of P8,481 as alleged deficiency income tax for the year 1950, inclusive of surcharges and penalties. On March 5, 1953, counsel for petitioners sent a letter to the Collector of Internal Revenue requesting the latter to withdraw and reconsider said assessment, contending among others, that the compensation paid to the spouses by the Government for their property was not "income derived from sale, dealing or disposition of property" referred to by section 29 of the Tax Code and therefore not taxable; that even granting that condemnation of private properties is embraced within the meaning of the word "sale" or "dealing", the compensation received by the taxpayers must be considered as income for 1948 and not for 1950 since the amount deposited and paid in 1948 represented more than 25 per cent of the total compensation awarded by the court; that the assessment was made after the lapse of the 3-year prescriptive period provided for in section 51-(d) of the Tax Code; that the compensation in question should be exempted from taxation by reason of the provision of section 29 (b)-6 of the Tax Code; that the spouses Blas Gutiérrez and Maria Morales did not realize any profit in said transaction as there were improvements on the land already made and

that the purchasing value of the peso at the time of the expropriation proceeding had depreciated if compared to the value of the pre-war peso; and that penalties should not be imposed on said spouses because granting that the assessment was correct, the omission of the compensation awarded therein was due to an honest mistake.

This request was denied by the Collector of Internal Revenue, in a letter dated April 26, 1954, refuting point by point the arguments advanced by the taxpayers. The record further shows that

a warrant of distraint and levy was issued by the Collector of Internal Revenue on the properties

of Mr. & Mrs. Blas Gutiérrez found in Mabalacat, Pampanga, and a notice of tax lien was duly registered with the Register of Deeds of San Fernando, Pampanga, on the same date. Counsel for the spouses then requested that the matter be referred to the Conference Staff of the Bureau of Internal Revenue for proper hearing, to which the Collector answered in a letter dated December 24, 1954, stating that the request would be granted upon compliance by the taxpayers with the requirements of Department of Finance Order No. 213, i.e., the filing of a

verified petition to that effect and that one-half of the total assessment should be guaranteed by

a bond, provided that the taxpayers would agree in writing to the suspension of the running of the period of prescription.

The taxpayers then served notice that the case would be brought on appeal to the Court of Tax Appeals, which they did by filing a petition with said Court to review the assessment made by the Collector of Internal Revenue, docketed as C.T.A. Case No. 65. In that instance, it was prayed that the Court render judgment declaring that the taking of petitioners’ land by the Government was not a sale or dealing in property; that the amount paid to petitioners as just compensation for their property should not be diminished by way of taxation; that said compensation was by law exempt from taxation and that the period to collect the income taxes by summary methods had prescribed; that respondent Collector of Internal Revenue be enjoined from carrying out further steps to collect from petitioners by summary methods the said taxes which they alleged to be erroneously assessed and for such other remedies which would serve the ends of law and justice.

The Solicitor General, in representation of the respondent Collector of Internal Revenue, filed an answer on February 11, 1955, admitting some of the allegations of petitioners and denying some of them, and as special defenses, he advanced the contention that the Court had no jurisdiction to entertain the petition; that the profit realized by petitioners from the sale of the land in question was subject to income tax; that the full compensation received by petitioners should be included in the income received in 1950, same having been paid in 1950 by the Government; that under the Bases Agreement only residents of the United States are exempt from the payment of income tax in the Philippines in respects to profits derived under a contract with the U.S. Government in connection with the construction, maintenance and operation of the bases; that in the determination of the gain or loss from the sale of property acquired on or after March 1, 1913, the cost of acquisition and the selling price shall be taken into account without qualification as to the purchasing power of the currency; that the imposition of the 50 per cent surcharge was in accordance with the Tax Code; that the Collector of Internal Revenue was empowered to collect petitioners’ deficiency income tax; and prayed that the petition for review

be dismissed; petitioners be ordered to pay the amount of P8,481 plus the delinquency penalty of 5 per cent for late payment and monthly interest at the rate of 1 per cent from April 1, 1953, up to the date of actual payment and for such other relief that may be deemed just and equitable in the premises.

After due hearing and after the parties had filed their respective memoranda, the Court of Tax Appeals rendered decision on August 31, 1955, holding that it had jurisdiction to hear and determine the case; that the gain derived by the petitioners from the expropriation of their property constituted taxable income and as such was capital gain; and that said gain was taxable in 1950 when it was realized. It was also found by said Court that the evidence did not warrant the imposition of the 50 per cent surcharge because the petitioners acted in good faith and without intent to defraud the Government when they failed to include in their gross income the proceeds they received from the expropriated property, and, therefore, modified the assessment made by respondent, requiring petitioners to pay only the sum of P5,654. From this decision, both parties appealed to this Court and in this instance, petitioners Blas Gutiérrez and Maria Morales, as appellants in G. R. No. L-9738, made the following assignments of error:chanrob1es virtual 1aw library

1. That the Court of Tax Appeals erred in holding that, for income tax purposes, income from

expropriation should be deemed as income from sale, any profit derived therefrom is subject to income tax as capital gain pursuant to the provisions of Section 37-(a)-(5) in relation to Section 29-(a) of the Tax Code;

2. That the Court of Tax Appeals erred in not holding that, under the particular circumstances in

which the property of the appellants was taken by the Philippine Government, the amount paid to them as just compensation is exempt from income tax pursuant to Section 29- (b)-(6) of the Tax Code;

3. That the Court of Tax Appeals erred in not holding that the respondent Collector is definitely

barred by the Statute of Limitations from collecting the deficiency income tax in question, whether administratively thru summary methods, or judicially thru the ordinary court procedures;

4. That the Court of Tax Appeals erred is not holding that the capital gain found by the

respondent Collector as have been derived by the petitioners-appellants from the expropriation

of their property is merely nominal not subject to income tax, and in not holding that the pronouncement of the court in the expropriation case in this respect is binding upon the respondent Collector of Internal Revenue; and

5. That the Court of Tax Appeals erred in not pronouncing upon the pleadings of the parties that

the petitioners-appellants did not derive any capital gain from the expropriation of their property.

The appeal of the respondent Collector of Internal Revenue was docketed in this Court as G. R. No. L-9771, and in this case the Solicitor General ascribed to the lower court the commission of the following error:chanrob1es virtual 1aw library

That the Court of Tax Appeals erred in holding that respondents are not subject to the payment of the 50 per cent surcharge in spite of the fact that the latter’s income tax return for the year 1950 is false and/or fraudulent.

The facts just narrated are not disputed and the controversy only arose from the assertion by the Collector of Internal Revenue that petitioners-appellants failed to include from their gross income, in filing their income tax return for 1950, the amount of P94,305.75 which they had received as compensation for their land taken by the Government by expropriation proceedings. It is the contention of respondent Collector of Internal Revenue that such transfer of property, for taxation purposes, is "sale" and that the income derived therefrom is taxable. The pertinent provisions of the National Internal Revenue Code applicable to the instant cases are the following:chanrob1es virtual 1aw library

SEC. 29. GROSS INCOME. — (a) General definition. — "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, sales or dealings in property, whether real or personal, growing out of ownership or use of or interest in such property; also from interests, rents, dividends, securities, or the transactions of any business carried on for gain or profit, or gains, profits, and income derived from any source whatsoever.

SEC. 37. INCOME FROM SOURCES WITHIN THE PHILIPPINES. —

(a) Gross income from sources within the Philippines. — The following items of gross income shall be treated as gross income from sources within the Philippines:chanrob1es virtual 1aw library

x x

x

(5) SALE OF REAL PROPERTY. — Gains profits, and income from the sale of real property located in the Philippines;

x x

x

There is no question that the property expropriated being located in the Philippines, compensation or income derived therefrom ordinarily has to be considered as income from sources within the Philippines and subject to the taxing jurisdiction of the Philippines. However, it is to be remembered that said property was acquired by the Government through condemnation proceedings and appellants’ stand is, therefore, that same cannot be considered as sale as said acquisition was by force, there being practically no meeting of the minds between the parties. Consequently, the taxpayers contend, this kind of transfer of ownership must perforce be distinguished from sale, for the purpose of Section 29-(a) of the Tax Code. But

the authorities in the United States on the matter sustain the view expressed by the Collector of Internal Revenue, for it is held that:jgc:chanrobles.com.ph

"The transfer of property through condemnation proceedings is a sale or exchange within the meaning of section 117 (a) of the 1936 Revenue Act and profit from the transaction constitutes capital gain" (1942. Com. Int. Revenue v. Kieselbach (CCA 3) 127 F. (24) 359). "The taking of property by condemnation and the payment of just compensation therefore is a ‘sale’ or ‘exchange’ within the meaning of section 117 (a) of the Revenue Act of 1936, and profits from that transaction is capital gain" (David S. Brown v. Comm., 1942, 42 BTA 139).

The proposition that income from expropriation proceedings is income from sales or exchange and therefore taxable has been likewise upheld in the case of Lapham v. U.S. (1949, 40 AFTR 1370) and in Kneipp v. U.S. (1949, 85 F Suppl. 902). It appears then that the acquisition by the Government of private properties through the exercise of the power of eminent domain, said properties being JUSTLY compensated, is embraced within the meaning of the term "sale" or "disposition of property", and the proceeds from said transaction clearly fall within the definition of gross income laid down by Section 29 of the Tax Code of the Philippines.

Petitioners-appellants also averred that granting that the compensation thus received is "income", same is exempted under Section 29-(b)-6 of the Tax Code, which reads as follows:chanrob1es virtual 1aw library

SEC. 29. GROSS INCOME. —

x x

x

(b) EXCLUSIONS FROM GROSS INCOME. — The following items shall not be included in gross income and shall be exempt from taxation under this Title:chanrob1es virtual 1aw library

x x

x

(6) Income exempt under treaty. — Income of any kind, to the extent required by any treaty obligation binding upon the Government of the Philippines.

The taxpayers maintain that since, at the request of the U.S. Government, the proceeding to expropriate the land in question necessary for the expansion of the Clark Field Air Base was instituted by the Philippine Government as part of its obligation under the Military Bases Agreement, the compensation accruing therefrom must necessarily fall under the exemption provided for by Section 29-(b)-6 of the Tax Code. We find this stand untenable, for the same Military Bases Agreement cited by appellants contains the following:jgc:chanrobles.com.ph

"CONDEMNATION OR EXPROPRIATION

"1. Whenever it is necessary to acquire by condemnation or expropriation proceedings real property belonging to private persons, association, or corporations located in bases named in Annex ‘A’ and Annex ‘B’ in order to carry out the purposes of this agreement, the Philippines will institute and prosecute such condemnation proceedings in accordance with the laws of the Philippines. The United States agrees to reimburse the Philippines for all the reasonable expanses, damages, and costs thereby incurred, including the value of the property as determined by the Court. In addition, subject to mutual agreements of the two governments, the United States shall reimburse the Philippines for the reasonable costs of transportation and removal of any occupants displaced or ejected by reason of the condemnation or expropriation"

"ARTICLE XII

"INTERNAL REVENUE EXEMPTION

"(1) No member of the United States Armed Forces except Filipino citizens, serving in the Philippines in connection with the bases and residing in the Philippines by reason only of such service, or his dependents, shall be liable to pay income tax in the Philippines except in respect of income derived from Philippine sources.

"(2) No national of the United States serving in the Philippines in connection with the construction, maintenance, operation or defense of the bases and residing in the Philippines by reason only of such employment, or his spouse and minor children and dependent parents of either spouse, shall be liable to pay income tax in the Philippines except in respect of income derived from Philippine sources or sources other than the United States.

"(3) No person referred to in paragraphs 1 and 2 of this said Article shall be liable to pay the government or local authorities of the Philippines any poll or residence tax, or any imports or experts duties, or any other tax on personal property imported for his own use provided, that private owned vehicles shall be subject to payment of the following only: when certified as being used for military purposes by appropriate United States Authorities, the normal license plate fee; otherwise, the normal license and registration fees.

"(4) No national of the United States, or corporation organized under the laws of the United States, shall be liable to pay income tax in the Philippines in respect of any profits derived under a contract made in the United States with the government of the United States in connection with the construction, maintenance, operation and defense of the bases, or any tax in the nature of a license in respect of any service of works for the United States in connection with the construction, maintenance, operation and defense of the bases.

x

x

x

The facts brought about by the aforementioned terms of the said treaty need no further elucidation. It is unmistakable that although the condemnation or expropriation of properties was provided for, the exemption from tax of the compensation to be paid for the expropriation of privately owned lands located in the Philippines was not given any attention, and the internal revenue exemptions specifically taken care of by said Agreement applies only to members of the U.S. Armed Forces serving in the Philippines and U.S. nationals working in these Islands in connection with the construction, maintenance, operation and defense of said bases.

Anent appellant taxpayers’ allegation that the respondent Collector of Internal Revenue was barred from collecting the deficiency income tax assessment, it having been made beyond the 3-year period prescribed by section 51-(d) of the Tax Code, We have this much to say. Although it is true that by order of the Court of First Instance of Pampanga, the amount of P34,580 out of the original deposit made by the Government was withdrawn in favor of appellants on January 27, 1949, the same cannot be considered as income for said year but for 1950 when the balance of P59,785.75 was actually received. Before that date (1950), appellant taxpayers were still the owners of their whole property that was subject of condemnation proceedings and said amount of P34,580 was not paid to, but merely deposited in court and withdrawn by them. Therefore, the payment of the value of Maria Morales’ Lot 724-C was actually made by the Republic of the Philippines in 1950 and it has to be credited as income for 1950 for it was then when title over said property passed to the Republic of the Philippines. Appellant tax payers cannot say that the title over the property expropriated already passed to the Government when the latter was placed in possession thereof, for in condemnation proceedings, title to the land does not pass to the plaintiff until the indemnity is paid (Calvo v. Zandueta, 49 Phil. 605), and notwithstanding possession acquired by the expropriator, title does not actually pass to him until payment of the amount adjudged by the Court and the registration of the judgment with the Register of Deeds (See Visayan Refining Company v. Camus Et. Al., 40 Phil. 550; Metropolitan Water District v. De los Angeles, 55 Phil. 783). Now, if said amount should have been reported as income for 1950 in the return that must have been filed on or before March 1, 1951, the assessment made by the Collector on January 28, 1953, is still within the 3-year prescriptive period provided for by Section 51-d and could, therefore, be collected either by the administrative methods of distraint and levy or by judicial action (See Collector of Internal Revenue v. A.P. Reyes Et. Al., 100 Phil., 822; Collector of Internal Revenue v. Zulueta Et. Al., 100 Phil., 872; and Sambrano v. Court of Tax Appeals Et. Al., supra, p. 1).

As to appellant taxpayers’ proposition that the profit derived by them from the expropriation of their property is merely nominal and not subject to income tax, We find Section 35 of the Tax Code illuminating. Said section reads as follows:jgc:chanrobles.com.ph

"SEC. 35. DETERMINATION OF GAIN OR LOSS FROM THE SALE OR OTHER DISPOSITION OF PROPERTY. — The gain derived or loss sustained from the sale or other disposition of property, real or personal, or mixed, shall be determined in accordance with the following schedule:chanrob1es virtual 1aw library

(b) In the case of property acquired on or after March first, nineteen hundred and thirteen, the cost thereof if such property was acquired by purchase or the fair market price or value as of the date of the acquisition if the same was acquired by gratuitous title.

x

x

x

The records show that the property in question was adjudicated to Maria Morales by order of the Court of First Instance of Pampanga on March 23, 1929, and in accordance with the aforequoted section of the National Internal Revenue Code, only the fair market price or value of the property as of the date of the acquisition thereof should be considered in determining the gain or loss sustained by the property owner when the property was disposed, without taking into account the purchasing power of the currency used in the transaction. The records placed the value of the said property at the time of its acquisition by appellant Maria Morales was P28,291.73 and it is a fact that same was compensated with P94,305.75 when it was expropriated. The resulting difference is surely a capital gain and should be correspondingly taxed.

As to the only question raised by appellant Collector of Internal Revenue in case L-9771, assailing the lower Court’s order exonerating petitioners from the 50 per cent surcharge imposed on the latter, on the ground that the taxpayers’ income tax return for 1950 is false and/or fraudulent, it should be noted that the Court of Tax Appeals found that the evidence did not warrant the imposition of said surcharge because the petitioners therein acted in good faith and without intent to defraud the Government.

"The question of fraud is a question of fact which frequently requires a nicely balanced judgment to answer. All the facts and circumstances surrounding the conduct of the taxpayer’s business and all the facts incident to the preparation of the alleged fraudulent return should be considered." (Mertens, Federal Income Taxation, Chapter 55).

The question of fraud being a question of fact and the lower court having made the finding that "the evidence of this case does not warrant the imposition of the 50 per cent surcharge", We are constrained to refrain from giving any consideration to the question raised by the Solicitor General, for it is already settled in this jurisdiction that in passing upon petitions to review decisions of the Court of Tax Appeals, We have to confine ourselves to questions of law.

Wherefore, the decision appealed from by both parties is hereby affirmed, without pronouncement as to costs. It is so ordered.

James v. United States, 366 U.S. 213 (1961)

James v. United States

No. 63

Argued November 17, 1960

Decided May 15, 1961

366 U.S. 213

CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

Syllabus

1. Embezzled money is taxable income of the embezzler in the year of the embezzlement under § 22(a) of the Internal Revenue Code of 1939, which defines "gross income" as including "gains or profits and income derived from any source whatever," and under § 61(a) of the Internal Revenue Code of 1954, which defines "gross income" as "all income from whatever source derived." Commissioner v. Wilcox, 327 U. S. 404, overruled. Pp. 366 U. S. 213-222.

2. After this Court's decision in Commissioner v. Wilcox, supra, petitioner embezzled large sums of money during the years 1951 through 1954. He failed to report those amounts as gross

income in his income tax returns for those years, and he was convicted of "willfully" attempting to evade the federal income tax due for each of the years 1951 through 1954, in violation of §145(b) of the Internal Revenue Code of 1939 and § 7201 of the Internal Revenue Code of

1954.

Held: the judgment affirming the conviction is reversed, and the cause is remanded with directions to dismiss the indictment. Pp. 366 U. S. 214-215, 222.

273 F.2d 5, reversed.

MR. CHIEF JUSTICE WARREN announced the judgment of the Court and an opinion in which MR. JUSTICE BRENNAN, and MR. JUSTICE STEWART concur.

The issue before us in this case is whether embezzled funds are to be included in the "gross income" of the embezzler in the year in which the funds are misappropriated

under § 22(a) of the Internal Revenue Code of 1939 [Footnote 1] and § 61(a) of the Internal Revenue Code of 1954. [Footnote 2]

The facts are not in dispute. The petitioner is a union official who, with another person, embezzled in excess of $738,000 during the years 1951 through 1954 from his employer union and from an insurance company with which the union was doing business. [Footnote 3] Petitioner failed to report these amounts in his gross income in those years, and was convicted for willfully attempting to evade the federal income tax due for each of the years 1951 through 1954 in violation of § 145(b) of the Internal Revenue Code of 1939 [Footnote 4] and § 7201 of the Internal Revenue

Page 366 U. S. 215

Code of 1954. [Footnote 5] He was sentenced to a total of three years' imprisonment. The Court of Appeals affirmed. 273 F.2d 5. Because of a conflict with this Court's decision in Commissioner v. Wilcox, 327 U. S. 404, a case whose relevant facts are concededly the same as those in the case now before us, we granted certiorari. 362 U.S. 974.

In Wilcox, the Court held that embezzled money does not constitute taxable income to the embezzler in the year of the embezzlement under § 22(a) of the Internal Revenue Code of 1939. Six years later, this Court held, in Rutkin v. United States, 343 U. S. 130, that extorted money does constitutes taxable income to the extortionist in the year that the money is received under § 22(a) of the Internal Revenue Code of 1939. In Rutkin, the Court did not overrule Wilcox, but stated:

"We do not reach in this case the factual situation involved in Commissioner v. Wilcox, 327 U. S. 404. We limit that case to its facts. There, embezzled funds were held not to constitute taxable income to the embezzler under § 22(a)."

Id. at 343 U. S. 138. [Footnote 6] However, examination of the reasoning used in Rutkin leads us inescapably to the conclusion that Wilcox was thoroughly devitalized.

The basis for the Wilcox decision was

"that a taxable gain is conditioned upon (1) the presence of a claim of right to the alleged gain and (2) the absence of a definite,

Page 366 U. S. 216

unconditional obligation to repay or return that which would otherwise constitute a gain. Without some bona fide legal or equitable claim, even though it be contingent or contested in nature, the taxpayer cannot be said to have received any gain or profit within the reach of Section 22(a)."

Commissioner v. Wilcox, supra, at 327 U. S. 408. Since Wilcox embezzled the money, held it "without any semblance of a bona fide claim of right," ibid., and therefore "was at all times under

an unqualified duty and obligation to repay the money to his employer," ibid., the Court found

that the money embezzled was not includible within "gross income." But Rutkin's legal claim was no greater than that of Wilcox. It was specifically found "that petitioner had no basis for his

claim

Both Wilcox and Rutkin obtained the money by means of a criminal act; neither had a bona fide claim of right to the funds. [Footnote 7] Nor was Rutkin's obligation to repay the extorted money to the victim any less than that of Wilcox. The victim of an extortion, like the victim of an embezzlement, has a right to restitution. Furthermore, it is inconsequential that an embezzler may lack title to the sums he appropriates, while an extortionist may gain a voidable title. Questions of federal income taxation are not determined by such "attenuated subtleties." Lucas v. Earl, 281 U. S. 111, 281 U. S. 114; Corliss v.

and that he obtained it by extortion." Rutkin v. United States, supra, at 343 U. S. 135.

Page 366 U. S. 217

Bowers, 281 U. S. 376, 281 U. S. 378. Thus, the fact that Rutkin secured the money with the consent of his victim, Rutkin v. United States, supra, at p. 343 U. S. 138, is irrelevant. Likewise unimportant is the fact that the sufferer of an extortion is less likely to seek restitution than one whose funds are embezzled. What is important is that the right to recoupment exists in both situations.

Examination of the relevant cases in the courts of appeals lends credence to our conclusion that the Wilcox rationale was effectively vitiated by this Court's decision in Rutkin. [Footnote 8] Although this case appears to be the first to arise that is "on all fours" with Wilcox, the lower federal courts, in deference to the undisturbed Wilcox holding, have earnestly endeavored to find distinguishing facts in the cases before them which would enable them to include sundry unlawful gains within "gross income." [Footnote 9]

Page 366 U. S. 218

It had been a well established principle, long before either Rutkin or Wilcox, that unlawful, as well as lawful, gains are comprehended within the term "gross income." Section II B of the Income Tax Act of 1913 provided that

"the net income of a taxable person shall include gains, profits, and income

transaction of any lawful business carried on for gain or profit, or gains or profits and income

derived from any source

from

the

."

(Emphasis supplied.) 38 Stat. 167. When the statute was amended in 1916, the one word "lawful" was omitted. This revealed, we think, the obvious intent of that Congress to tax income derived from both legal and illegal sources, to remove the incongruity of having the gains of the honest laborer taxed and the gains of the dishonest immune. Rutkin v. United States, supra, at 343 U. S. 138; United States v. Sullivan, 274 U. S. 259, 274 U. S. 263. Thereafter, the Court held that gains from illicit traffic in liquor are includible within "gross income." Ibid. See also Johnson v. United States, 318 U. S. 189; United States v. Johnson, 319 U. S. 503. And, the

Court has pointed out, with approval, that there "has been a widespread and settled administrative and judicial recognition of the taxability of unlawful gains of many kinds," Rutkin v. United States, supra, at 343 U. S. 137. These include protection payments made to racketeers, ransom payments paid to kidnappers, bribes, money derived from the sale of unlawful insurance policies, graft, black market gains, funds obtained from the operation of lotteries, income from race track bookmaking and illegal prize fight pictures. Ibid.

The starting point in all cases dealing with the question of the scope of what is included in "gross income" begins with the basic premise that the purpose of Congress was "to use the full measure of its taxing power." Helvering

Page 366 U. S. 219

v. Clifford, 309 U. S. 331, 309 U. S. 334. And the Court has given a liberal construction to the broad phraseology of the "gross income" definition statutes in recognition of the intention of Congress to tax all gains except those specifically exempted. Commissioner v. Jacobson, 336 U. S. 28, 336 U. S. 49; Helvering v. Stockholms Enskilda Bank, 293 U. S. 84, 293 U. S. 87-91. The language of § 22(a) of the 1939 Code, "gains or profits and income derived from any source whatever," and the more simplified language of § 61(a) of the 1954 Code, "all income from whatever source derived," have been held to encompass all "accessions to wealth, clearly realized, and over which the taxpayers have complete dominion."Commissioner v. Glenshaw Glass Co., 348 U. S. 426, 348 U. S. 431. A gain

"constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it."

Rutkin v. United States, supra, at 343 U. S. 137. Under these broad principles, we believe that petitioner's contention, that all unlawful gains are taxable except those resulting from embezzlement, should fail.

When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition,

"he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent."

North American Oil Consolidated v. Burnet, supra, at 286 U. S. 424. In such case, the taxpayer has "actual command over the property taxed-the actual benefit for which the tax is paid," Corliss v. Bowers, supra. This standard brings wrongful appropriations within the broad sweep of "gross income;" it excludes loans. When a law-abiding taxpayer mistakenly receives income in one year, which receipt is assailed and found to be invalid in a subsequent

year, the taxpayer must nonetheless report the amount as "gross income" in the year received. United States v. Lewis, supra; Healy v. Commissioner, supra. We do not believe that Congress intended to treat a lawbreaking taxpayer differently. Just as the honest taxpayer may deduct any amount repaid in the year in which the repayment is made, the Government points out that "If, when, and to the extent that the victim recovers back the misappropriated funds, there is, of course, a reduction in the embezzler's income." Brief for the United States, p. 24. [Footnote 10]

Petitioner contends that the Wilcox rule has been in existence since 1946; that, if Congress had intended to change the rule, it would have done so; that there was a general revision of the income tax laws in 1954 without mention of the rule; that a bill to change it [Footnote 11] was introduced in the Eighty-sixth Congress, but was not acted upon; that therefore we may not change the rule now. But the fact that Congress has remained silent or has reenacted a statute which we have construed, or that congressional attempts to amend a rule announced by this Court have failed, does not necessarily debar us from reexamining and correcting the Court's own errors. Girouard v. United States, 328 U. S. 61, 328 U. S. 69-70; Helvering v. Hallock, 309 U. S. 106, 309 U. S. 119-122. There may have been any number of reasons why Congress acted as it did. Helvering v. Hallock, supra. One of the reasons could well 8 and <="" a="" style="box-sizing: border-box;">S. 221 be our subsequent decision in Rutkin which has been thought by many to have repudiated Wilcox. Particularly might this be true in light of the decisions of the Courts of Appeals which have been riding a narrow rail between the two cases and further distinguishing them to the disparagement of Wilcox. See notes 8 and <="" a="" style="box-sizing: border-box;">| 8 and <="" a="" style="box-sizing: border-box;">S. 213fn9|>9, supra.

We believe that Wilcox was wrongly decided, and we find nothing in congressional history since then to persuade us that Congress intended to legislate the rule. Thus, we believe that we should now correct the error and the confusion resulting from it, certainly if we do so in a manner that will not prejudice those who might have relied on it. Cf. Helvering v. Hallock, supra, at 309 U. S. 119. We should not continue to confound confusion, particularly when the result would be to perpetuate the injustice of relieving embezzlers of the duty of paying income taxes on the money they enrich themselves with through theft while honest people pay their taxes on every conceivable type of income.

But we are dealing here with a felony conviction under statutes which apply to any person who "willfully" fails to account for his tax or who "willfully" attempts to evade his obligation. In Spies v. United States, 317 U. S. 492, 317 U. S. 499, the Court said that § 145(b) of the 1939 Code embodied "the gravest of offenses against the revenues," and stated that willfulness must therefore include an evil motive and want of justification in view of all the circumstances. Id. at 317 U. S. 498. Willfulness

"involves a specific intent which must be proven by independent evidence, and which cannot be inferred from the mere understatement of income."

Holland v. United States, 348 U. S. 121, 348 U. S. 139.

We believe that the element of willfulness could not be proven in a criminal prosecution for failing to include embezzled funds in gross income in the year of misappropriation so long as the statute contained the gloss placed upon it by Wilcox at the time the alleged crime was

Page 366 U. S. 222

committed. Therefore, we feel that petitioner's conviction may not stand, and that the indictment against him must be dismissed.

Since MR. JUSTICE HARLAN, MR. JUSTICE FRANKFURTER, and MR. JUSTICE CLARK agree with us concerning Wilcox, that case is overruled. MR. JUSTICE BLACK, MR. JUSTICE DOUGLAS, and MR. JUSTICE WHITTAKER believe that petitioner's conviction must be reversed and the case dismissed for the reasons stated in their opinions.

Accordingly, the judgment of the Court of Appeals is reversed, and the case is remanded to the District Court with directions to dismiss the indictment.

It is so ordered.

[Footnote 1]

"§ 22. GROSS INCOME."

"(a) General definitions. -- 'Gross income' includes gains, profits, and income derived from

salaries, wages, or compensation for personal service

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 carried on for gain or profit, or gains or profits and income derived from any source ."

of whatever kind and in whatever

(26 U.S.C. (1952 ed.) § 22(a).)

[Footnote 2]

"§ 61. Gross Income Defined."

"(a) General Definition. -- Except as otherwise provided in this subtitle, gross income means all

income from whatever source

."

(26 U.S.C. § 61(a).)

Petitioner has pleaded guilty to the offense of conspiracy to embezzle in the Court of Essex County, New Jersey.

[Footnote 4]

"§ 145. Penalties."

"* * * *"

"(b) Failure to Collect and Pay Over Tax, or Attempt to Defeat or Evade Tax. -- Any person required under this chapter to collect, account for, and pay over any tax imposed by this chapter, who willfully fails to collect or truthfully account for and pay over such tax, and any person who willfully attempts in any manner to evade or defeat any tax imposed by this chapter or the payment thereof, shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, be fined not more than $10,000 or imprisoned for not more than five years, or both, together with the costs of prosecution."

(26 U.S.C. (1952 ed.) § 145(b).)

[Footnote 5]

"§ 7201. Attempt to Evade or Defeat Tax."

"Any person who willfully attempts in any manner to evade or defeat any tax imposed by this title or the payment thereof shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $10,000, or imprisoned not more than 5 years, or both, together with the costs of prosecution."

26 U.S.C. § 7201.

[Footnote 6]

The dissenters in Rutkin stated that the Court had rejected the Wilcox interpretation of § 22(a). Id. at 343 U. S. 140.

[Footnote 7]

The Government contends that the adoption in Wilcox of a claim of right test as a touchstone of taxability had no support in the prior cases of this Court; that the claim of right test was a doctrine invoked by the Court in aid of the concept of annual accounting, to determine when, not whether, receipts constituted income. See North American Oil Consolidated v. Burnet, 286 U. S. 417; United States v. Lewis, 340 U. S. 590; Healy v. Commissioner, 345 U. S. 278. In view of our reasoning set forth below, we need not pass on this contention. The use to which we put the claim of right test here is only to demonstrate that, whatever its validity as a test of whether certain receipts constitute income, it calls for no distinction between Wilcox and Rutkin.

[Footnote 8]

In Marienfeld v. United States, 214 F.2d 632, the Eighth Circuit stated, "We find it difficult to

reconcile the Wilcox case with the later opinion of the Supreme Court in

The Second Circuit announced, in United States v. Bruswitz, 219 F.2d 59, "It is difficult to

perceive what, if anything, is left of the Wilcox holding after

Circuit's prior decision in Macias v. Commissioner, 255 F.2d 23, observed,

." Id. at 636.

." Id. at 61. The Seventh

"If this reasoning [of Rutkin] had been employed in Wilcox, we see no escape from the conclusion that the decision in that case would have been different. In our view, the Court in Rutkin repudiated its holding in Wilcox; certainly it repudiated the reasoning by which the result was reached in that case."

Id. at 26.

[Footnote 9]

For example, Kann v. Commissioner, 210 F.2d 247, was differentiated on the following grounds:

the taxpayer was never indicted or convicted of embezzlement; there was no adequate proof that the victim did not forgive the misappropriation; the taxpayer was financially able to both pay the income tax and make restitution; the taxpayer would have likely received most of the misappropriated money as dividends. In Marienfeld v. United States, supra, the court believed that the victim was not likely to repudiate. In United States v. Wyss, 239 F.2d 658, the distinguishing factors were that the district judge had not found as a fact that the taxpayer embezzled the funds, and the money had not as yet been reclaimed by the victim.See also Briggs v. United States, 214 F.2d 699, 702; Prokop v. Commissioner, 254 F.2d 544, 554- 555. Cf. J. J. Dix, Inc. v. Commissioner, 223 F.2d 436.

[Footnote 10]

Petitioner urges upon us the case of Alison v. United States, 344 U. S. 167. But that case dealt with the right of the victim of an embezzlement to take a deduction, under § 23(e) and (f) of the 1939 Code, in the year of the discovery of the embezzlement, rather than the year in which the embezzlement occurred. The Court held only

"that the special factual circumstances found by the District Courts in both these cases justify deductions under I.R.C., § 23(e) and (f) and the longstanding Treasury Regulations applicable to embezzlement losses."

Id. at 344 U. S. 170. The question of inclusion of embezzled funds in "gross income" was not presented in Alison.

[Footnote 11]

H.R. 8854, 86th Cong., 1st Sess.

MR. JUSTICE BLACK, whom MR. JUSTICE DOUGLAS joins, concurring in part and dissenting in part.

On February 25, 1946, fifteen years ago, this Court, after mature consideration, and in accordance with what at that time represented the most strongly supported judicial view, held, in an opinion written by Mr. Justice Murphy to which only one Justice dissented, that money secretly taken by an embezzler for his own use did not constitute a taxable gain to him under the federal income tax laws. Commissioner v. Wilcox, 327 U. S. 404. The Treasury Department promptly accepted this ruling in a bulletin declaring that the "mere act of embezzlement does not, of itself, result in taxable income," although properly urging that "taxable income may result to the embezzler depending on the facts in the particular case." [Footnote 2/1]

Page 366 U. S. 223

During the fifteen years since Wilcox was decided, both this Court and Congress, although urged to do so, have declined to change the Wilcox interpretation of statutory "income" with respect to embezzlement. In this case, however, a majority of the Court overrules Wilcox. Only three of the members of the Court who decided the Wilcox case are participating in this case -- MR. JUSTICE FRANKFURTER, MR. JUSTICE DOUGLAS, and myself. MR. JUSTICE DOUGLAS and I dissent from the Court's action in "overruling" Wilcox and from the prospective way in which this is done. We think Wilcox was sound when written, and is sound now.

I

We dissent from the way the majority of the Court overrules Wilcox. If the statutory interpretation of "taxable income" in Wilcox is wrong, then James is guilty of violating the tax evasion statute, for the trial court's judgment establishes that he embezzled funds and willfully refrained from reporting them as income. It appears to us that District Courts are bound to be confused as to what they can do hereafter in tax evasion cases involving "income" from embezzlements committed prior to this day. Three Justices vote to overrule Wilcox under what we believe to be a questionable formula, at least a new one in the annals of this Court, and say that, although failure to report embezzled funds has, despite Wilcox, always been a crime under the statute, people who have violated this law in the past cannot be prosecuted, but people who embezzle funds after this opinion is announced can be prosecuted for failing to report these funds as a "taxable gain." Three other Justices who vote to overrule Wilcox say that past embezzlers can be prosecuted for the crime of tax evasion, although two of those Justices believe the Government must prove that the past embezzler did not commit his crime in reliance on Wilcox.

Page 366 U. S. 224

Thus, although it was not the law yesterday, it will be the law tomorrow that funds embezzled hereafter are taxable income; and although past embezzlers could not have been prosecuted yesterday, maybe they can and maybe they cannot be prosecuted tomorrow for the crime of tax evasion. (The question of the civil tax liability of past embezzlers is left equally unclear.) We do

not challenge the wisdom of those of our Brethren who refuse to make the Court's new tax evasion crime applicable to past conduct. This would be good governmental policy even though the ex post facto provision of the Constitution has not ordinarily been thought to apply to judicial legislation. Our trouble with this aspect of the Court's action is that it seems to us to indicate that the Court has passed beyond the interpretation of the tax statute and proceeded substantially to amend it.

We realize that there is a doctrine with wide support to the effect that ,under some circumstances, courts should make their decisions as to what the law is apply only prospectively. [Footnote 2/2] Objections to such a judicial procedure, however, seem to us to have peculiar force in the field of criminal law. In the first place, a criminal statute that is so ambiguous in scope that an interpretation of it brings about totally unexpected results, thereby subjecting people to penalties and punishments for conduct which they could not know was criminal under existing law, raises serious questions of unconstitutional vagueness. [Footnote 2/3] Moreover, for a court to interpret a criminal statute in such a way as to make punishment for past conduct under it so unfair and unjust that the interpretation should be given only prospective application seems to us to be the creation of a judicial crime that Congress might not want

Page 366 U. S. 225

to create. This country has never been sympathetic with judge-created crimes. Their rejection under our Constitution was said to have been "long since settled in public opinion" even as early as 1812, when the question first reached this Court in United States v. Hudson & Goodwin, 7 Cranch 32. In that case, this Court emphatically declared that the federal courts have no common law jurisdiction in criminal cases. They are not "vested with jurisdiction over any particular act done by an individual in supposed violation of the peace and dignity of the sovereign power." Rather,

"[t]he legislative authority of the Union must first make an act a crime, affix a punishment to it, and declare the Court that shall have jurisdiction of the offence. [Footnote 2/4]"

In our judgment, one of the great inherent restraints upon this Court's departure from the field of interpretation to enter that of lawmaking has been the fact that its judgments could not be limited to prospective application. This Court, and, in fact, all departments of the Government, have always heretofore realized that prospective lawmaking is the function of Congress, rather than of the courts. We continue to think that this function should be exercised only by Congress under the constitutional system.

II

We think Wilcox was right when it was decided, and is right now. It announced no new, novel doctrine. One need only look at the Government's briefs in this Court in the Wilcox case to see just how little past judicial support could then be mustered had the Government sought to send

Wilcox to jail for his embezzlement under the guise of a tax evasion prosecution. The Government did cite many cases from many courts saying that, under the federal income tax law, gains are no less taxable because

Page 366 U. S. 226

they have been acquired by illegal methods. This Court had properly held long before Wilcox that there is no "reason why the fact that a business is unlawful should exempt it from paying the taxes that, if lawful, it would have to pay." [Footnote 2/5] We fully recognize the correctness of that holding in Wilcox:

"Moral turpitude is not a touchstone of taxability. The question, rather, is whether the taxpayer in fact received a statutory gain, profit or benefit. That the taxpayer's motive may have been reprehensible or the mode of receipt illegal has no bearing upon the application of Section 22(a). [Footnote 2/6]"

The Court today by implication attributes quite a different meaning or consequence to

the Wilcox opinion. One opinion argues at length the "well established principle

unlawful, as well as lawful, gains are comprehended within the term gross income.'" Wilcox did not deny that; we do not deny that. This repeated theme of our Brethren is wholly irrelevant, since the Wilcox holding in no way violates the sound principle of treating "gains" of honest and dishonest taxpayers alike. The whole basis of the Wilcox opinion was that an embezzlement is not in itself "gain" or "income" to the embezzler within the tax sense, for the obvious reason that the embezzled property still belongs, and is known to belong, to the rightful owner. It is thus a mistake to argue that petitioner's contention is "that all unlawful gains are taxable except those resulting from embezzlement."

that

As stated in Wilcox, that case was brought to us because of a conflict among the Circuits. The Ninth Circuit in Wilcox had held that embezzled funds were not any more "taxable income" to the embezzler than

Page 366 U. S. 227

borrowed funds would have been. [Footnote 2/7] The Fifth Circuit, in McKnight v. Commissioner, had decided the same thing. [Footnote 2/8] The Eighth Circuit, however, had decided in Kurrle v. Helvering that embezzled funds were taxable income. [Footnote 2/9] Comparison of the three opinions readily shows that the arguments of the Fifth and Ninth Circuits against taxability of such funds were much stronger than the arguments of the Eighth Circuit for such taxability. The whole picture can best to obtained from the court's opinion in McKnight v. Commissioner, written by Judge Sibley, one of the ablest circuit judges of his time. He recognized that the taxpayer could not rely upon the unlawfulness of his business to defeat taxation if he had made a "gain" in that business. He pointed out, however, that the ordinary embezzler

"got no title, void or voidable, to what he took. He was still in possession as he was before, but with a changed purpose. He still had no right nor color of right. He claimed none. [Footnote

2/10]"

Judge Silbley's opinion went on to point out that the

"first takings [of an embezzler] are, indeed, nearly always with the intention of repaying, a sort of unauthorized borrowing. It must be conceded that no gain is realized by borrowing, because of the offsetting obligation. [Footnote 2/11]"

Approaching the matter from a practical standpoint, Judge Sibley also explained that subjecting the embezzled funds to a tax would amount to allowing the United States "a preferential claim for part of the dishonest gain, to the direct loss and detriment of those to whom it ought to be restored." [Footnote 2/12] He was not willing to put the owner of

Page 366 U. S. 228

funds that had been stolen in competition with the United States Treasury Department as to which one should have a preference to get those funds.

It seems to us that Judge Sibley's argument was then, and is now, unanswerable. The rightful owner who has entrusted his funds to an employee or agent has troubles enough when those funds are embezzled, without having the Federal Government step in with its powerful claim that the embezzlement is a taxable event automatically subjecting part of those funds (still belonging to the owner) to the waiting hands of the Government's tax gatherer. We say part of the owner's funds because it is on the supposed "gain" from them that the embezzler is now held to be duty- bound to pay the tax, and history probably records few instances of independently wealthy embezzlers who have had nonstolen assets available for payment of taxes.

There has been nothing shown to us on any of the occasions when we have considered this problem to indicate that Congress ever intended its income tax laws to be construed as imposing what is in effect a property or excise tax on the rightful owner's embezzled funds, for which the owner has already once paid income tax when he rightfully acquired them. In our view, the Court today does Congress a grave injustice by assuming that it has imposed this double tax burden upon the victim of an embezzlement merely because someone has stolen his money, particularly when Congress has refused requests that it do so. The owner whose funds have been embezzled has done nothing but entrust an agent with possession of his funds for limited purposes, as many of us have frequent occasion to do in the course of business or personal affairs. Ordinarily the owner is not, and has no reason to be, at all aware of an embezzlement until long after the first misuse occurs. If Congress ever did manifest an intention to select the mere fact of embezzlement

as the basis for imposing a double tax on the owner, we think a serious question of confiscation in violation of the Fifth Amendment would be raised. All of us know that, with the strong lien provisions of the federal income tax law, an owner of stolen funds would have a very rocky road to travel before he got back, without paying a good slice to the Federal Government, such funds as an embezzler who had not paid the tax might, perchance, not have dissipated. An illustration of what this could mean to a defrauded employer is shown in this very case by the employer's loss of some $700,000, upon which the Government claims a tax of $559,000.

It seems to be implied that one reason for overruling Wilcox is that a failure to hold embezzled funds taxable would somehow work havoc with the public revenue or discriminate against "honest" taxpayers and force them to pay more taxes. We believe it would be impossible to substantiate either claim. Embezzlers ordinarily are not rich people against whom judgments, even federal tax judgments, can be enforced. Judging from the meager settlements that those defrauded were apparently compelled to make with the embezzlers in this very case, it is hard to imagine that the Treasury will be able to collect the more than $500,000 it claims. And certainly the Wilcox case does not seem to have been one in which the Government could have collected any great amount of tax. The employer's embezzled $11,000 there went up in gambling houses. The scarcity of cases involving alleged taxes due from embezzlers is another indication that the Government cannot expect to make up any treasury deficits with taxes collected from embezzlers and thieves, especially when the cost to the Government of investigations and court proceedings against suspected individuals is considered. And, as already indicated, to the extent that the Government could be successful in collecting some taxes from

Page 366 U. S. 230

embezzlers, it would most likely do so at the expense of the owner whose money had been stolen.

It follows that, except for the possible adverse effect on rightful owners, the only substantial result that one can foresee from today's holding is that the Federal Government will, under the guise of a tax evasion charge, prosecute people for a simple embezzlement. But the Constitution grants power to Congress to get revenue, not to prosecute local crimes. And if there is any offense which, under our dual system of government, is a purely local one which the States should handle, it is embezzlement or theft. The Federal Government stands to lose much money by trying to take over prosecution of this type of local offense. It is very doubtful whether the further congestion of federal court dockets to try such local offenses is good for the Nation, the States or the people. Here, the embezzler has already pleaded guilty to the crime of embezzlement in a state court, although the record does not show what punishment he has received. Were it not for the novel formula of applying the Court's new law prospectively, petitioner would have to serve three years in federal prison in addition to his state sentence. This graphically illustrates one of the great dangers of opening up the federal tax statutes, or any others, for use by federal prosecutors against defendants who not only can be but are tried for their crimes in local state courts and punished there. If the people of this country are to be

subjected to such double jeopardy and double punishment, despite the constitutional command against double jeopardy, it seems to us it would be far wiser for this Court to wait and let Congress attempt to do it.

III

The Wilcox case was decided fifteen years ago. Congress has met every year since then. All of us know that the House and Senate Committees responsible for our

Page 366 U. S. 231

tax laws keep a close watch on judicial rulings interpreting the Internal Revenue Code. Each committee has one or more experts at its constant disposal. It cannot possibly be denied that these committees and these experts are, and have been, fully familiar with the Wilcox holding. When Congress is dissatisfied with a tax decision of this Court, it can and frequently does act very quickly to overturn it. [Footnote 2/13] On one occasion, such an overruling enactment was passed by both the House and Senate and signed by the President all within one day after the decision was rendered by this Court. [Footnote 2/14] In 1954, Congress, after extended study, completely overhauled and recodified the Internal Revenue Code. The Wilcox holding was left intact. In the Eighty-sixth Congress, and in the present Eighty-seventh Congress, bills have been introduced to subject embezzled funds to income taxation. [Footnote 2/15] They have not been passed. This is not an instance when we can say that Congress may have neglected to change the law because it did not know what

Page 366 U. S. 232

was going on in the courts or because it was not asked to do so, as was the case in Helvering v. Hallock. [Footnote 2/16] Nor is this a case in which subsequent affirmative congressional action manifested a view inconsistent with our prior decision, as was true in Girouard v. United States. [Footnote 2/17] What we have here, instead, is a case in which Congress has not passed bills that have been introduced to make embezzled funds taxable and thereby make failure to report them as income a federal crime. For this Court to hold under such circumstances that the inherent ambiguity of legislative inaction gives the Court license to repudiate the longstanding interpretation of the income tax statute, and thereby bring additional conduct within the tax evasion criminal statute, seems to us to be flagrantly violative of the almost universally accepted axiom that criminal statutes are narrowly and strictly construed. Our Brethren cite no precedent in which this or any other court in the English-speaking world has so deliberately overruled a longstanding prior interpretation of a statute in order to create a crime which up to that time did not exist.

This Court, as well as Congress, was fully apprised of the various criticisms made in some Courts of Appeals opinions and elsewhere against the Wilcox holding, yet it has likewise, until today, steadfastly refused to overrule that holding during these fifteen years. This has been in

the face of the fact that the Government expressly urged that we do so in 1955, nine years after Wilcox was decided

Page 366 U. S. 233

and three years after the decision in Rutkin v. United States, 343 U. S. 130. On that occasion, the Court of Appeals for the Second Circuit, speaking through Judge Frank for himself and Judge Medina, had held in the case of J. J. Dix, Inc. v. Commissioner that embezzled funds were not taxable as income, relying wholly on the Wilcox decision. [Footnote 2/18] Judge Hincks dissented, saying that, if the facts of Dix were not enough to distinguish it from Wilcox, he would not follow Wilcox. In urging us to grant certiorari, the Government said that the case presented a recurring problem in the administration of the income tax laws. One of the arguments the Government presented for overruling Wilcox, strange as it may seem, was that

"[s]everal prosecutions have recently been authorized and are now pending in various District Courts, even though the disputed income in those cases apparently came from embezzlements or closely analogous crimes. [Footnote 2/19]"

And the next to the last sentence of its petition was:

"In short, the question whether the proceeds of embezzlement, unlike other illegal income, are to enjoy a preferred tax-exempt status will continue to perplex the lower courts until it is settled by this Court. [Footnote 2/20]"

We denied certiorari. [Footnote 2/21] There is surely less reason to repudiate and "devitalize" Wilcox now, six years after the Court, as composed at that time, refused to overrule it.

Of course, the rule of stare decisis is not and should not be an inexorable one. This is particularly true with reference to constitutional decisions involving determinations beyond the power of Congress to change, but Congress can and does change statutory interpretations. It

Page 366 U. S. 234

is perfectly proper and right that it should do so when it believes that this Court's interpretation of a statute embodies a policy that Congress is against. But Congress has not taken favorable action on bills introduced to overturn our Wilcox holding even after we declined the Government's request to reverse the identical holding in Dix, the latter having occurred three years after the decision in Rutkin which our Brethren now say may have misled Congress into thinking that we had repudiated the Wilcox holding.

It seems to us that we gave the doctrine of stare decisis its proper scope in our treatment of this Court's decision in Federal Baseball Club v. National League of Professional Baseball Clubs, 259 U. S. 200. In that case, this Court had held, for reasons given, that professional baseball was not covered by the antitrust acts. Congress was asked through the years to

change the law in this respect, but declined to do so. In Toolson v. New York Yankees, Inc., 346 U. S. 356, we followed the holding of that case without reexamination of the underlying issues

"so far as that decision determines that Congress had no intention of including the business of baseball within the scope of the federal antitrust laws."

Later, we were asked to extend the Federal Baseball case and to hold that the business of boxing could not, without congressional action, be brought within the antitrust laws. We emphatically declined to do so in United States v. International Boxing Club, 348 U. S. 236, nor did we overrule Toolson in that case, despite strong arguments that the reasoning of the Court in the first baseball case was equally applicable to the business of boxing. We said about the proposed exemption of boxing from the antitrust laws that "[t]heir remedy, if they are entitled to one, lies in further resort to Congress." [Footnote 2/22] That case and that statement fit this case precisely. In fact, as we are about to explain, a

Page 366 U. S. 235

far more meaningful distinction can be made between embezzlement and extortion for purposes of this case than it was possible to make between baseball and boxing for purposes of that case, as MR. JUSTICE FRANKFURTER's dissenting opinion in that case demonstrates.

If the Government wants to prosecute the local crime of embezzlement, ostensibly because of "tax evasion," it seems clear to us that it should take its request to Congress, which has power to pass on it and which has, to date, refused to do what the Government asks us to do in this case.

IV

Our Brethren advance as a reason for overruling Wilcox the 1952 decision in Rutkin v. United States, which was decided three years before we denied certiorari in the Dix case. They say that "the reasoning used in Rutkin leads us inescapably to the conclusion that Wilcox was thoroughly devitalized." This follows, to some extent, the statement in the Government's brief that

"Wilcox and Rutkin cannot be reconciled on the basis of asserted technical differences between

the extortionist and the

the Wilcox rationale was rejected in Rutkin, is unsound, and can no longer be regarded as having vitality. Embezzled funds represent taxable gains. [Footnote 2/23]"

The proper course, we submit,

is to recognize that

There is no doubt that some of the reasoning in the Rutkin opinion rejected some of the reasoning in the Wilcox opinion. But this it true only with respect to the broad general standards formulated in the two cases, and such standards, of course, cannot be accepted as universal panaceas to be mechanically applied to solve all the concrete problems in cases like these. Moreover, the Rutkin opinion expressly purported not to overrule Wilcox and

Page 366 U. S. 236

specifically said that Wilcox was still to govern cases fitting its facts, clearly meaning embezzlement cases. [Footnote 2/24] And the Government had not asked in Rutkin that Wilcox be overruled. Its argument was that Wilcox was "inapplicable" to the facts in the Rutkin record. The Government's brief went on to emphasize that the record in Wilcox showed only the bare receipt of money wholly belonging to another, while Rutkin had received the money "as a result of a bilateral agreement" and, as the Court of Appeals had pointed out,

"with a 'semblance of a bona fide claim of right,' a conclusion fully substantiated by the testimony of both the petitioner and the Government witness Reinfeld. [Footnote 2/25]"

The Government went on to distinguish Rutkin further by pointing out that there was "not the slightest hint in the record" that Rutkin ever had an obligation to repay the funds he took.

After this Court was persuaded by the Government in Rutkin to accept its distinctions between Rutkin and Wilcox, it seems rather odd to have the Government now contend that the two cases are irreconcilable. While we disagreed, we can understand why the majority in Rutkin

Page 366 U. S. 237

drew the distinctions it did. Although the victim of either embezzlement or extortion ordinarily has a legal right to restitution, the extortion victim, like a blackmail victim, can in a sense be charged with complicity in bringing about the taxable event in that he knowingly surrendered the funds to the extortionist, sometimes in payment of an actual obligation. Unlike the victim of an ordinary theft, he generally knows who has taken the property from him, and he consents to the taking though under duress; and unlike most victims of embezzlement, he is able to report the taking to law enforcement officers during the taxable year, and his failure to do so might be considered a kind of continuing consent to the extortionist's dominion over the property. The longer he acquiesces, the less likely it becomes that the extortion victim ever will demand restitution; [Footnote 2/26] but once the victim of an embezzlement finds out that his property has been stolen, he most likely will immediately make efforts to get it back. Thus, although we still think Rutkin was wrongly decided for the reasons expressed in the dissenting opinion in that case, we can understand the argument for application of a sort of caveat emptor rule to persons who submit to blackmail or extortion, since it is far from certain that they will ever expose themselves by seeking repayment of what they paid out. The distinctions between crimes like embezzlement and crimes like blackmail and extortion, therefore, are not merely

Page 366 U. S. 238

technical, legalistic "attenuated subleties" for purposes of this decision, but are differences based upon practicalities such as often underlie the distinctions that have been developed in our law.

In departing from both the Wilcox and Rutkin decisions today, our Brethren offer no persuasive reasons to prove that their judgment in overruling Wilcox is better than that of the Justices who decided that case. It contributes nothing new to the analysis of this problem to say repeatedly that the dishonest man must be subject to taxation, just as the honest. As already said, Chief Justice Stone and the others sitting with him on the Wilcox Court fully accepted that general principle, and we do still. Applying it here, we would say the embezzler should be treated just like the law-abiding, honest borrower who has obtained the owner's consent to his use of the money. [Footnote 2/27] It

Page 366 U. S. 239

would be unthinkable to tax the borrower on his "gain" of the borrowed funds, and thereby substantially impair the lender's chance of ever recovering the debt. The injury that the Government would inflict on the lender by making the borrower less able to repay the loan surely would not be adequately compensated by telling the lender that he can take a tax deduction for the loss, and it is equally small comfort to the embezzlement victim for the Government, after taking part of his property as a tax on the embezzler, to tell the victim that he can take a deduction for his loss if he has any income against which to offset the deduction. There is, of course, one outstanding distinction between a borrower and an embezzler, and that is that the embezzler uses the funds without the owner's consent. This distinction can be of no importance for purposes of taxability of the funds, however, because, as a matter of common sense, it suggests that there is, if anything, less reason to tax the embezzler than the borrower. But if this distinction is to be the reason why the embezzlement must be taxed just as "the gains of the honest laborer," then the use of this slogan in this case is laid bare as no more than a means of imposing a second punishment for the crime of embezzlement without regard to revenue considerations, the effect on the rightful owner, or the proper role of this Court when asked to overrule a criminal statutory precedent. The double jeopardy implications would seem obvious, [Footnote 2/28]

Page 366 U. S. 240

and discussion of the serious inadvisability for other reasons of thus injecting the Federal Government into local law enforcement can be found in the dissenting opinion in Rutkin.

We regret very much that it seems to be implied that the writer of the Rutkin opinion and those who agreed to it intended to overrule Wilcox when it is manifest that the language the Court used in Rutkin was meant to leave precisely the opposite impression. We are sure that our Brethren at that time did not intend to mislead the public, and it would be hard to imagine why they said what they did in the Rutkin opinion had they not specifically considered and rejected the possibility of overruling Wilcox then and there. We think it is unjustifiable to say nine years after Rutkin that it "devitalized" or "repudiated" the Wilcox holding when the Rutkin opinion said explicitly that Wilcox is still the rule as to embezzlement. Congress has seen fit to let both decisions stand, and we think the present Court should do the same.

V

Even if we were to join with our Brethren in accepting the Government's present contention that Wilcox and Rutkin cannot both stand, we would disagree as to which of the two decisions should now be repudiated. This is true not only because we would feel less inhibition about narrowing, rather than broadening, the reach of a previously construed criminal statute. Regardless of such considerations, our conviction that the Rutkin case was wrongly decided in this Court remains undiminished and has been further substantiated by the subsequent events in that controversy, which show all the more clearly the deplorable consequences that can result when federal courts subject people who violate state criminal laws to

Page 366 U. S. 241

a double or treble prosecution for the state crime under the guise of attempted enforcement of federal tax laws. [Footnote 2/29]

For the foregoing reasons, as well as the reasons stated in MR. JUSTICE WHITTAKER's opinion, we would reaffirm our holding in Commissioner v. Wilcox, reverse this judgment and direct that the case be dismissed.

[Footnote 2/1]

G.C.M. No. 24945, 1946-2 Cum.Bull. 27, 28. This was precisely in accord with this Court's statement of the proper rule in the Wilcox opinion:

"Taxable income may arise, to be sure, from the use or in connection with the use of such

[embezzled]

wholly belonging to another lacks the essential characteristics of a gain or profit within the meaning of Section 22(a)."

But, apart from such factors, the bare receipt of property or money

327 U.S. at 327 U. S. 408.

[Footnote 2/2]

See, for example, Great Northern R. Co. v. Sunburst Oil & Refining Co., 287 U. S. 358.

[Footnote 2/3]

See, for example, United States v. L. Cohen Grocery Co., 255 U. S. 81.

[Footnote 2/4]

7 Cranch at 11 U. S. 34. And see United States v. Coolidge, 1 Wheat. 415.

United States v. Sullivan, 274 U. S. 259, 274 U. S. 263.

[Footnote 2/6]

327 U.S. at 327 U. S. 408.

[Footnote 2/7]

Wilcox v. Commissioner, 148 F.2d 933.

[Footnote 2/8]

127 F.2d 572.

[Footnote 2/9]

126 F.2d 723.

[Footnote 2/10]

127 F.2d at 573.

[Footnote 2/11]

Ibid. The same reasoning can be found in our opinion in Alison v. United States, 344 U. S. 167, 344 U. S. 169-170.

[Footnote 2/12]

127 F.2d at 574.

[Footnote 2/13]

E.g., Commissioner v. Smith, 324 U. S. 177 (compensation through exercise of stock option), led to § 218 of the Revenue Act of 1950, adding § 130A to the 1939 Code; Commissioner v. Tower, 327 U. S. 280; Lusthaus v. Commissioner, 327 U. S. 293; and Commissioner v. Culbertson, 337 U. S. 733 (family partnerships), led to § 340 of the Revenue Act of 1951, adding § 191 to the 1939 Code; United States v. Silk, 331 U. S. 704 ("employees" for purpose of Social Security employment tax), led to the Joint Resolution of June 14, 1948, c. 468, 62 Stat. 438, amending several sections of the 1939 Code; Commissioner v. Estate of Church, 335 U. S. 632, and Estate of Spiegel v. Commissioner, 335 U. S. 701 (estate tax), led to the Act of October 25, 1949, § 7, 63 Stat. 891, 894, amending § 811(c) of the 1939 Code; Wilmette Park Dist. v. Campbell, 338 U. S. 411 (amusement tax), led to § 402 of the Revenue Act of 1951, adding § 1701(d) to the 1939 Code; Commissioner v. Korell, 339 U. S. 619 (amortization of

bond premium), led to § 217 of the Revenue Act of 1950, amending § 125(b)(1) of the 1939 Code.

[Footnote 2/14]

46 Stat. 1516; see 74 Cong.Rec. 7078-7079, 7198-7199.

[Footnote 2/15]

H.R. 8854, 86th Cong., 1st Sess.; H.R. 312, 87th Cong., 1st Sess.

[Footnote 2/16]

"To explain the cause of nonaction by Congress when Congress itself sheds no light is to venture into speculative unrealities. Congress may not have had its attention directed to an undesirable decision; and there is no indication that, as to the St. Louis Trust cases, it had, even by any bill that found its way into a committee pigeonhole."

309 U. S. 309 U.S. 106, 309 U. S. 119-120. (Emphasis supplied.)

[Footnote 2/17]

"Thus, the affirmative action taken by Congress in 1942 negatives any inference that otherwise might be drawn from its silence when it reenacted the oath in 1940."

328 U. S. 328 U.S. 61, 328 U. S. 70.

[Footnote 2/18]

223 F.2d 436.

[Footnote 2/19]

Petition for certiorari, p. 14, n. 6, Commissioner v. Estate of Dix, 350 U.S. 894.

[Footnote 2/20]

Id. at 15.

[Footnote 2/21]

350 U.S. 894.

348 U.S. at 348 U. S. 244.

[Footnote 2/23]

Brief for the United States, pp. 32-33.

[Footnote 2/24]

"We do not reach in this case the factual situation involved in Commissioner v. Wilcox, 327 U. S. 404. We limit that case to its facts. There, embezzled funds were held not to constitute taxable income to the embezzler under § 22(a). The issue here is whether money extorted from a victim with his consent induced solely by harassing demands and threats of violence is included in the definition of gross income under § 22(a)."

343 U.S. at 343 U. S. 138.

[Footnote 2/25]

Brief for the United States in Opposition to Petition for Certiorari, Rutkin v. United States, 343 U. S. 130, pp. 13-14. The full sentence in the Court of Appeals opinion from which the Government quoted was:

"So he [Rutkin] did receive the money with a 'semblance of a bona fide claim of right,' as the embezzler had not in Commissioner of Internal Revenue v. Wilcox, supra, at 327 U. S. 408."

United States v. Rutkin, 189 F.2d 431, 435.

[Footnote 2/26]

This factual distinction was clearly emphasized in the Court's opinion in Rutkin:

"[Rutkin] induced Reinfeld to consent to pay the money by creating a fear in Reinfeld that harm otherwise would come to him and to his family. Reinfeld thereupon delivered his own money to petitioner. Petitioner's control over the cash so received was such that, in the absence of Reinfeld's unlikely repudiation of the transaction and demand for the money's return, petitioner could enjoy its use as fully as though his title to it were unassailable."

Rutkin v. United States, 343 U. S. 130, 343 U. S. 136-137. (Emphasis supplied.)

[Footnote 2/27]

The analogy between the borrower and the embezzler was lucidly analyzed by Judge Sibley in McKnight v. Commissioner, 127 F.2d 572, 573-574.

The several cases relied on by the Court do not, in our judgment, justify imposing a tax upon embezzled money. Corliss v. Bowers, 281 U. S. 376, involved income accumulating in a trust fund belonging to the taxpayer and over which he retained control. North American Oil Consolidated v. Burnet, 286 U. S. 417; United States v. Lewis, 340 U. S. 590; and Healy v. Commissioner, 345 U. S. 278, were cases in which the taxpayer had asserted a bona fide, though mistaken, claim of right. In North American Oil, the taxpayer not only had a bona fide claim to the money taxed, but there had been an adjudication that he was entitled to it, and there was only the tenuous possibility that a competing claimant might later upset that adjudication. The Lewis and Healy cases involved a tax on payments made and received as a result of mutual mistake, and it was held that the administration of the tax laws on an annual basis need not be upset for the convenience of those who caused the mistaken payments to be made and reported as income. By contrast, the victims do not cause embezzlements, and the Government is not misled or inconvenienced under Wilcox, because the embezzler is always fully aware that the embezzled funds are not rightfully his, and presumably will not report otherwise.

[Footnote 2/28]

See the dissenting opinion in Bartkus v. Illinois, 359 U. S. 121, 359 U. S. 150. It is interesting to note that, on July 22, 1959, shortly after the Bartkus decision, Illinois, in order to avoid the danger of prosecuting men in both state and federal courts for the same crime, passed a statute making conviction or acquittal in a federal prosecution a defense to a state prosecution for the same criminal act. Illinois Laws, 1959, p. 1893, § 1; 38 Ill.Ann.Stat. (Cum.Supp.1960) § 601.1. Thus, while Illinois is moving away from such double prosecutions, this Court is moving even further than Bartkus in the direction of authorizing such prosecutions.

[Footnote 2/29]

The subsequent history of the Rutkin-Reinfeld controversy can, in part, be read in United States v. Rutkin, 208 F.2d 647, especially Judge Kalodner's dissenting opinion at 655; United States v. Rutkin, 212 F.2d 641, especially at 644; and Rutkin v. Reinfeld, 122 F.Supp. 265, reversed, 229 F.2d 248.

MR. JUSTICE CLARK, concurring in part and dissenting in part as to the opinion of THE CHIEF JUSTICE.

Although I join in the specific overruling of Commissioner v. Wilcox, 327 U. S. 404 (1946), in THE CHIEF JUSTICE's opinion, I would affirm this conviction on either of two grounds. I believe that the Court not only devitalized Wilcox, by limiting it to its facts in Rutkin v. United States, 343 U. S. 130 (1952), but that, in effect, the Court overruled that case sub silentio in Commissioner v. Glenshaw Glass Co., 348 U. S. 426 (1955). Even if that not be true, in my view, the proof shows conclusively that petitioner, in willfully failing to correctly report his income, placed no bona fide reliance on Wilcox.

MR. JUSTICE HARLAN, whom MR. JUSTICE FRANKFURTER joins, concurring in part and dissenting in part as to the opinion of THE CHIEF JUSTICE.

I fully agree with so much of THE CHIEF JUSTICE's opinion as dispatches Wilcox to a final demise. But, as to the disposition of this case, I think that, rather than an outright reversal, which his opinion proposes, the reversal should be for a new trial.

Page 366 U. S. 242

I share the view that it would be inequitable to sustain this conviction when, by virtue of the Rutkin-Wilcox dilemma, it might reasonably have been thought by one in petitioner's position that no tax was due in respect of embezzled moneys. For, as is pointed out, Rutkin did not expressly overrule Wilcox, but instead merely confined it "to its facts." Having now concluded that Wilcox was wrongly decided originally, the problem in this case thus becomes one of how to overrule Wilcox "in a manner that will not prejudice those who might have relied on it." 366 U.S. at 366 U. S. 221.

It is argued, in reliance on Spies v. United States, 317 U. S. 492, and Holland v. United States, 348 U. S. 121, that, so long as Wilcox remained on the books, the element of "willfulness" required in prosecutions of this kind [Footnote 3/1] "could not be proven," and hence, that the conviction of this petitioner fails without more. This would mean, I take it, that no future prosecution or past conviction involving tax derelictions of this nature, occurring during the Wilcox period, may be brought or allowed to stand. I cannot agree to such a disposition, which, in my view, is warranted by neither principle nor authority, and would carry mischievous implications for the future.

The Spies and Holland cases, which are said to support outright reversal, stand for no more than that where, as here, a criminal tax statute makes "willfulness" an element of the offense, the Government must prove an "evil motive and want of justification in view of all the financial circumstances" on the part of the defendant in failing to do what was required of him. While I agree that, in the present case, this made germane on the issue of willfulness the petitioner's reliance or nonreliance on the

Page 366 U. S. 243

continued vitality of the Wilcox doctrine, [Footnote 3/2] I can find nothing in Spies or Holland which justifies the view that the mere existence of Wilcox suffices alone to vitiate petitioner's conviction as a matter of law. If, as appears to have been the case, there was erroneous failure to take that factor into account at the trial on the issue of willfulness, the most that should happen is that petitioner should be given a new trial. This indeed is what Spies and Holland affirmatively indicate as the right solution of the problem this case presents. In Spies, it was said (at 317 U. S. 499-500):

By way of Illustration, and not by way of limitation, we would think affirmative willful attempt may be inferred from conduct such as keeping a double set of books, making false entries or alterations, or false invoices or documents, destruction of books or records, concealment of assets or covering up sources of income, handling of one's affairs to avoid making the records usual in transactions of the kind, and any conduct, the likely effect of which would be to mislead or to conceal. If the tax evasion motive plays any part in such conduct, the offense may be made out even though the conduct may also serve other purposes, such as concealment of other crime."

"In this case, there are several items of evidence, apart from the default in filing the return and paying the tax, which the Government claims will support an inference of willful attempt to evade or

Page 366 U. S. 244

defeat the tax. These go to establish that petitioner insisted that certain income be paid to him in cash, transferred it to his own bank by armored car, deposited it not in his own name, but in the names of others of his family, and kept inadequate and misleading records. Petitioner claims other motives animated him in these matters. We intimate no opinion. Such inferences are for the jury. If, on proper submission, the jury found these acts, taken together with willful failure to file a return and willful failure to pay the tax, to constitute a willful attempt to defeat or evade the tax, we would consider conviction of a felony sustainable."

To the same effect, see Holland, supra, at p. 348 U. S. 139.

In the case at hand, the evidence of devious financial arrangements might well support the inference that petitioner's purpose was not only to commit the embezzlement, but also to secrete and immunize his gains from what he considered to be his tax liabilities in respect of those gains. The District Court, as the trier of the facts (there having been no jury), found that petitioner's acts were "willful, and were done in a knowing and conscious attempt to evade and defeat" his tax obligations. But since it does not appear that petitioner's possible reliance on the Wilcox doctrine was considered below, Spies and Holland make it appropriate for us to send the case back for a new trial. They do not support foreclosing the Government from even undertaking to prove that the petitioner's conduct was "willful" in this respect.

An outright reversal is equally unsound on principle. I take it that our decisions in the tax, and any other field, for that matter, relate back to the actual transactions with which they are concerned, and that that is only the normal concomitant of the fact that we do not sit as an administrative agency making rulings for the future, but rather adjudicate actual controversies as

Page 366 U. S. 245

to rights and liabilities under the laws of the United States. There can be, I think, two justifications for barring a prosecution of this petitioner in the unusual circumstances presented

here: (1) that, by reason of Rutkin having formally left intact the Wilcox doctrine, petitioner did not have due warning of his possible criminal liability; and (2) that the Court, in making new "law" in Rutkin, should, like the legislature, not impose criminal liability ex post facto.

As to the first consideration, where the defendant is charged in a case like this with having "willfully" violated the law, I believe that both reason and authority require no more than that the trier of fact be instructed that it must take into account in determining the defendant's "evil motive and want of justification," Spies v. United States, 317 U.S. at 317 U. S. 498, his possible reliance on Wilcox, which not until now has this Court explicitly stated was wrongly decided. As far as fairness to this petitioner is concerned, I do not see why that is not amply accorded by the disposition which Spies itself exemplifies. See p. 366 U. S. 243 supra. On the other hand, if the trier of fact, properly instructed, finds that the petitioner did not act in bona fide reliance on Wilcox, but deliberately refused to report income and pay taxes thereon knowing of his obligation to do so and not relying on any exception in the circumstances, I do not see why even the strictest definition of the element of "willfulness" would not have been satisfied. Willfulness goes to motive, and the quality of a particular defendant's motive would not seem to be affected by the fact that another taxpayer similarly situated had a different motive.

An altogether analogous situation was presented in United States v. Murdock, 290 U. S. 389. In that case, the respondent had been convicted of willfully failing to supply information to the Bureau of Internal Revenue in that he relied on the possibility of state prosecution as

Page 366 U. S. 246

justifying his invoking the federal privilege against self-incrimination. The Court said in that case:

He whose conduct is defined as criminal is one who 'willfully' fails to pay the tax, to make a return, to keep the required records, or to supply the needed information. Congress did not intend that a person, by reason of a bona fide misunderstanding as to his liability for the tax, should become a criminal by his mere failure to measure up to the prescribed standard of ."

"It follows that the respondent was entitled to the charge he requested with respect to his good faith and actual belief. Not until this court pronounced judgment in United States v. Murdock, 284 U. S. 141, had it been definitely settled that one under examination in a federal tribunal could not refuse to answer on account of probable incrimination under state law. The question was involved, but not decided, in Ballman v. Fagin, 200 U. S. 186, 200 U. S. 195, and specifically reserved in Vajtauer v. Comm'r of Immigration, 273 U. S. 103, 273 U. S. 113. The trial court could not, therefore, properly tell the jury the defendant's assertion of the privilege was so unreasonable and ill founded as to exhibit bad faith and establish willful wrongdoing. This was the effect of the instructions given. We think the Circuit Court of Appeals correctly upheld the respondent's right to have the question of absence of evil motive submitted to the ."

(Emphasis supplied.) It would seem that precisely the same disposition is in order in this case. Nor do I think that distinctions in terms of the nature of the defendant's legal misapprehension, its degree, its justifiability, or its source are either warranted or would be manageable as a basis for deciding future cases.

Page 366 U. S. 247

Coming now to the other possible rationale for barring the prosecution of this petitioner, it might be argued that petitioner, at the time he failed to make his return, was not under any misapprehension as to the law, but indeed that, at the time and under the decisions of this Court, his view of the law was entirely correct. The argument not only seems to beg the question, but raises further questions as to the civil liability of one situated in the circumstances of this petitioner. Petitioner's obligation here derived not from the decisions of this or any other court, but from the Act of Congress imposing the tax. It is hard to see what further point is being made once it is conceded that petitioner, if he was misled by the decisions of this Court, is entitled to plead in defense that misconception. Only in the most metaphorical sense has the law changed: the decisions of this Court have changed, and the decisions of a court interpreting the acts of a legislature have never been subject to the same limitations which are imposed on legislatures themselves, United States Constitution, Art, I, §§ 9, 10, forbidding them to make any ex post facto law, [Footnote 3/3] and, in the case of States, to impair the obligation

Page 366 U. S. 248

of a contract. Ross v. Oregon, 227 U. S. 150; New Orleans Waterworks Co. v. Louisiana Sugar Refining Co., 125 U. S. 18.

The proper disposition of this case, in my view, is to treat as plain error, Fed.Rules Crim.Proc. 52(b), the failure of the trial court as trier of fact to consider whatever misapprehension may have existed in the mind of the petitioner as to the applicable law in determining whether the Government had proved that petitioner's conduct had been willful as required by the statute. On that basis, I would send the case back for a new trial.

[Footnote 3/1]

The relevant statutes are set forth in footnotes 1-2 4-5 of THE CHIEF JUSTICE's opinion Ante, pp. 214-215.

[Footnote 3/2]

Compare American Law Institute, Model Penal Code, tentative draft No. 4, § 2.04:

"(1) Ignorance or mistake as to a matter of fact or law is a defense if:"

"(a) the ignorance or mistake negatives the purpose, knowledge, belief, recklessness or

negligence required to establish a material element of the

."

[Footnote 3/3]

Aside from problems of warning and specific intent, the policy of the prohibition against ex post facto legislation would seem to rest on the apprehension that the legislature, in imposing penalties on past conduct, even though the conduct could properly have been made criminal and even though the defendant who engaged in that conduct in the past believed he was doing wrong (as, for instance, when the penalty is increased retroactively on an existing crime), may be acting with a purpose not to prevent dangerous conduct generally, but to impose by legislation a penalty against specific persons or classes of persons. That this policy is inapplicable to decisions of the courts seems obvious: their opportunity for discrimination is more limited than the legislature's, in that they can only act in construing existing law in actual litigation. Given the divergent pulls of flexibility and precedent in our case law system, it is disquieting to think what perplexities and what subtleties of distinction would be created in applying this policy, which so properly limits legislative action, to the decisions of the courts.

MR. JUSTICE WHITTAKER, whom MR. JUSTICE BLACK and MR. JUSTICE DOUGLAS join, concurring in part and dissenting in part.

The starting point of any inquiry as to what constitutes taxable income must be the Sixteenth Amendment, which grants Congress the power "to lay and collect taxes on incomes, from

whatever source

of taxable income were intended "to use the full measure of (the Sixteenth Amendment's) taxing power." Helvering v. Clifford, 309 U. S. 331, 309 U. S. 334; Douglas v. Willcuts, 296 U. S. 1, 296 U. S. 9. Equally well settled is the principle that the Sixteenth Amendment "is to be taken as written, and is not to be extended beyond the meaning clearly indicated by the language used." Edwards v. Cuba R. Co., 268 U. S. 628, 268 U. S. 631. [Footnote 4/1] The language of

the Sixteenth Amendment, as well as our prior controlling decisions,

." It has long been settled that Congress' broad statutory definitions

Page 366 U. S. 249

compels me to conclude that the question now before us -- whether an embezzler receives taxable income at the time of his unlawful taking -- must be answered negatively. Since the prevailing opinion reaches an opposite conclusion, I must respectfully dissent from that holding, although I concur in the Court's judgment reversing petitioner's conviction. I am convinced that Commissioner v. Wilcox, 327 U. S. 404, which is today overruled, was correctly decided on the basis of every controlling principle used in defining taxable income since the Sixteenth Amendment's adoption.

THE CHIEF JUSTICE's opinion, although it correctly recites Wilcox's holding that "embezzled money does not constitute taxable income to the embezzler in the year of the embezzlement" (emphasis added), fails to explain or to answer the true basis of that holding. Wilcox did not hold that embezzled funds may never constitute taxable income to the embezzler. To the contrary, it expressly recognized that an embezzler may realize a taxable gain to the full extent of the amount taken if and when it ever becomes his. The applicable test of taxable income, i.e., the

"presence of a claim of right to the alleged gain," of which Wilcox spoke, was but a correlative statement of the factor upon which the decision placed its whole emphasis throughout, namely, the "absence of a definite, unconditional obligation to repay or return [the money]." 327 U.S. at 327 U. S. 408. In holding that this test was not met at the time of the embezzlement, the Wilcox opinion repeatedly stressed that the embezzler had no "bona fide legal or equitable claim" to the embezzled funds, ibid.; that the victim never "condoned or forgave the taking of the money, and still holds him liable to restore it," id. at 327 U. S. 406; and that the "debtor-creditor relationship was definite and unconditional." Id. at 327 U. S. 409. These statements all express the same basic fact -- the fact which is emphasized most strongly in the opinion's conclusion explaining

Page 366 U. S. 250

why the embezzler had not yet received taxable income:

"Sanctioning a tax under the circumstances before us would serve only to give the United States an unjustified preference as to part of the money which rightfully and completely belongs to the taxpayer's employer."

Id. at 327 U. S. 410. (Emphasis added.)

However, Wilcox plainly stated that, "if the unconditional indebtedness is cancelled or retired, taxable income may adhere, under certain circumstances, to the taxpayer." 327 U.S. at 327 U. S. 408. More specifically, it recognized that, had the embezzler's victim "condoned or forgiven any part of the [indebtedness], the [embezzler] might have been subject to tax liability to that extent," id. at 327 U. S. 410, i.e., in the tax year of such forgiveness.

These statements reflect an understanding of, and regard for, substantive tax law concepts solidly entrenched in our prior decisions. Since our landmark case of United States v. Kirby Lumber Co., 284 U. S. 1, it has been settled that, upon a discharge of indebtedness by an event other than full repayment, the debtor realizes a taxable gain in the year of discharge to the extent of the indebtedness thus extinguished. Such gains are commonly referred to as ones realized through "bargain cancellations" of indebtedness, and it was in this area, and, indeed, in Kirby Lumber Co. itself, that the "accession" theory or "economic gain" concept of taxable income, upon which THE CHIEF JUSTICE's opinion today mistakenly relies, found its genesis. In that case, the taxpayer, a corporation, had reduced a portion of its debt, with a corresponding gain in assets, by purchasing its bonds in the open market at considerably less than their issue price. Mr. Justice Holmes, who wrote the Court's opinion, found it unnecessary to state the elementary principle that, so long as the bonds remained a fully enforceable debt obligation of the taxpayer, there could be no taxable gain. However, when the taxpayer retired the debt by purchasing

Page 366 U. S. 251

the bonds for less than their face value, it "made a clear [taxable] gain," and "realized within the year an accession to income" in the amount of its bargain. 284 U.S. at 284 U. S. 3.

This doctrine has since been reaffirmed and strengthened by us, see e.g., Helvering v. American Chicle Co., 291 U. S. 426; Commissioner v. Jacobson, 336 U. S. 28, and by the lower federal courts in numerous decisions involving a variety of "bargain cancellations" of indebtedness, as by a creditor's release condoning or forgiving the indebtedness in whole or in part, [Footnote 4/2] or by the running of a statute of limitations barring the legal enforceability of the obligation. [Footnote 4/3] In none of these cases has it been suggested that a taxable gain might be realized by the debtor at any time prior to the effective date of discharge, and, as Wilcox recognized, there is no rational basis on which to justify such a rule where the debt arises through embezzlement.

An embezzler, like a common thief, acquires not a semblance of right, title, or interest in his plunder, and, whether he spends it or not, he is indebted to his victim in the full amount taken as surely as if he had left a signed promissory note at the scene of the crime. Of no consequence from any standpoint is the absence of such formalities as (in the words of the prevailing opinion) "the consensual recognition, express or implied, or an obligation to repay." The law readily implies whatever "consensual recognition" is needed for the rightful owner to assert an immediately ripe and enforceable obligation of

Page 366 U. S. 252

repayment against the wrongful taker. These principles are not "attenuated subtleties," but are among the clearest and most easily applied rules of our law. They exist to protect the rights of the innocent victim, and we should accord them full recognition and respect.

The fact that an embezzler's victim may have less chance of success than other creditors in seeking repayment from his debtor is not a valid reason for us further to diminish his prospects by adopting a rule that would allow the Commissioner of Internal Revenue to assert and enforce a prior federal tax lien against that which "rightfully and completely belongs" to the victim. Commissioner v. Wilcox, supra, at 327 U. S. 410. THE CHIEF JUSTICE's opinion quite understandably expresses much concern for "honest taxpayers," but it attempts neither to deny nor justify the manifest injury that its holding will inflict on those honest taxpayers, victimized by embezzlers, who will find their claims for recovery subordinated to federal tax liens. Statutory provisions, by which we are bound, clearly and unequivocally accord priority to federal tax liens over the claims of others, including "judgment creditors." [Footnote 4/4]

Page 366 U. S. 253

However, if it later happens that the debtor-creditor relationship between the embezzler and his victim is discharged by something other than full repayment, such as by the running of a statute of limitations against the victim's claim, or by a release given for less than the full amount owed, the embezzler, at that time, but not before, will have made a clear taxable gain and realized "an

accession to income" which he will be required, under full penalty of the law, to report in his federal income tax return for that year. No honest taxpayer could be harmed by this rule.

The inherent soundness of this rule could not be more clearly demonstrated than as applied to the facts of the case before us. Petitioner, a labor union official, concededly embezzled sums totaling more than $738,000 from the union's funds over a period extending from 1951 to 1954. When the shortages were discovered in 1956, the union at once filed civil actions against petitioner to compel repayment. For reasons which need not be detailed here, petitioner effected a settlement agreement with the union on July 30, 1958, whereby, in exchange for releases fully discharging his indebtedness, he repaid to the union the sum of $13,568.50. Accordingly, at least so far as the present record discloses, petitioner clearly realized a taxable gain in the year the releases were executed to the extent of the difference between the amount taken and the sum restored. However, the Government brought the present action against him not for his failure to report this gain in his 1958 return, but for his failure to report that he had incurred "income" from -- actually indebtedness to -- the union in each of the years 1951 through 1954. It is true that the Government brought a criminal evasion prosecution, rather than a civil deficiency proceeding, against petitioner, but this can in no way alter the substantive tax law rules which alone are determinative of liability in either case.

Page 366 U. S. 254

There can be no doubt that, until the releases were executed in 1958, petitioner and the union stood in an absolute and unconditional debtor-creditor relationship, and, under all of our relevant decisions, no taxable event could have occurred until the indebtedness was discharged for less than full repayment. Application of the normal rule in such cases will not hinder the efficient and orderly administration of the tax laws any more than it does in other situations involving "bargain cancellations" of indebtedness. More importantly, it will enhance the creditor's position by assuring that prior federal tax liens will not attach to the subject of the debt when he seeks to recover it.

Notwithstanding all of this, THE CHIEF JUSTICE's opinion concludes that there is no difference between embezzled funds and "gains" from other "illegal sources," and it points to the fact that Congress, in its 1916 revision of the 1913 Income Tax Act, omitted the word "lawful" in describing businesses whose income was to be taxed. The opinion then cites United States v. Sullivan, 274 U. S. 259, in which it was held that, under the revised statute, gains from illicit traffic in liquor must be reported in gross income, since there is no "reason why the fact that a business is unlawful should exempt it from paying the taxes that, if lawful, it would have to pay." Id. at 274 U. S. 263. (Emphasis added.) That theory has been the primary basis for taxing "unlawful gains of many kinds" which the prevailing opinion today recites, such as black market profits, gambling proceeds, money derived from the sale of unlawful insurance policies, etc. [Footnote 4/5] For, even if lawful, the gains from such activities would clearly

Page 366 U. S. 255

not be exempted from taxation. However, as applied to embezzled funds, the holding in Sullivan contradicts, rather than supports, the Court's conclusion today. Obviously, embezzlement could never become "lawful" and still retain its character. If "lawful," it would constitute nothing more than a loan, or possibly a gift, to the "embezzler," neither of which would produce a taxable gain to him.

There is still another obvious and important distinction between embezzlement and the varieties of illegal activity listed by the prevailing opinion -- one which clearly calls for a different tax treatment. Black marketeering, gambling, bribery, graft, and like activities generally give rise to no legally enforceable right of restitution -- to no debtor-creditor relationship which the law will recognize. [Footnote 4/6] Condemned either by statute or public policy, or both, such transactions are void ab initio. Since any consideration which may have passed is not legally recoverable, its recipient has realized a taxable gain, an "accession to income," as clearly as if his "indebtedness" had been discharged by a full release or by the running of a statute of limitations. As we have already shown at length, quite the opposite is true when an embezzlement occurs; for then the victim acquires an immediately ripe and enforceable claim to repayment, and the embezzler assumes a legal debt equal to his acquisition.

To reach the result that it does today, THE CHIEF JUSTICE's opinion constructs the following theory for defining taxable income:

"When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition,

Page 366 U. S. 256

express or implied, of an obligation to repay and without restriction as to their disposition,"

"he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent."

"North American Oil Consolidated v. Burnet, supra, 286 U. S. 424. In such case, the taxpayer has 'actual command over the property taxed -- the actual benefit for which the tax is paid,' Corliss v. Bowers, supra. This standard brings wrongful appropriations within the broad sweep of 'gross income;' it excludes loans. When a law-abiding taxpayer mistakenly receives income in one year, which receipt is assailed and found to be invalid in a subsequent year, the taxpayer must nonetheless report the amount as 'gross income' in the year received. United States v. Lewis, supra; Healy v. Commissioner, supra."

This novel formula finds no support in our prior decisions, least of all in those which are cited. Corliss v. Bowers, 281 U. S. 376, involved nothing more than an inter vivos trust created by the taxpayer to pay the income to his wife. Since he had reserved the power to alter or abolish the trust at will, its income was taxable to him under the express provisions of § 219(g), (h) of the Revenue Act of 1924. North American Oil Consolidated v. Burnet, 286 U. S. 417, is

the case which introduced the principle since used to facilitate uniformity and certainty in annual tax accounting procedure, i.e., that a taxpayer must report in gross income, in the year in which received, money or property acquired under a "claim of right" -- a colorable claim of the right to exclusive possession of the money or property. Thus, in its complete form, the sentence in North American Oil from which the above-quoted fragment was extracted reads:

"If a taxpayer receives earnings under a claim of right and without

Page 366 U. S. 257

restriction as to its [sic] disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent."

Id. at 286 U. S. 424. (Emphasis added.) But embezzled funds, like stolen property generally, are not "earnings" in any sense, and are held without a vestige of a colorable claim of right; they constitute the principal of a debt. Of no significance whatever is the formality of "consensual recognition, express or implied" of an obligation to repay. By substituting this meaningless abstraction in place of the omitted portion of the North American Oil test of when a receipt constitutes taxable income, the prevailing opinion today goes far beyond overruling Wilcox -- it reduces a substantial body of tax law into uncertainty and confusion. The above-cited case of United States v. Lewis, 340 U. S. 590, decided 19 years after North American Oil, demonstrates the truth of this. For, there we said:

"The 'claim of right' interpretation of the tax laws has long been used to give finality to [the

accounting] period, and is not deeply rooted in the federal tax

why the Court should depart from this well settled interpretation merely because it results in an

advantage or disadvantage to a taxpayer."

We see no reason

340 U.S. at 340 U. S. 592. The same principle was reiterated and applied in Healy v. Commissioner, 345 U. S. 278.

The supposed conflict between Wilcox and Rutkin, upon which THE CHIEF JUSTICE's opinion seeks to justify its repudiation of Wilcox, [Footnote 4/7] has been adequately treated in

Page 366 U. S. 258

the opinion of MR. JUSTICE BLACK, and I agree with him that those cases were fully intended to be, and are, reconcilable both on their controlling facts and applicable law. If the unnecessarily broad language used in the Rutkin opinion has misled any of the lower federal courts in their understanding of the principles underlying Wilcox, we should clarify their understanding at this time, and continue our adherence to "a prior doctrine more embracing in its scope, intrinsically sounder, and verified by experience." Helvering v. Hallock, 309 U. S. 106, 309 U. S. 119.

Wisconsin v. Illinois

No. 1, Original

Decree April 21, 1930

Decree enlarged May 22, 1933

Decree entered June 12, 1967*

388 U.S. 426

The Court, having reopened Nos. 1, 2 and 3, Original, and having granted leave to file No. 11, Original, entered this decree.

Decree reported, 281 U. S. 281 U.S. 696; decree enlarged, 289 U. S. 289 U.S. 395.

Page 388 U. S. 427

DECREE

This Court having reopened Original cases Nos. 1, 2, and 3, and having granted leave to file Original case No. 11, and having referred all such cases to a Special Master who has filed his Report, and the parties having agreed to the form of the decree, the Findings of Fact in the Report are hereby adopted, and it being unnecessary at this time to consider the Special Master's legal conclusions,

IT IS ORDERED, ADJUDGED, AND DECREED that:

1. The State of Illinois and its municipalities, political subdivisions, agencies, and instrumentalities, including, among others, the cities of Chicago, Evanston, Highland Park, Highwood and Lake Forest, the villages of Wilmette, Kenilworth, Winnetka, and Glencoe, the Elmhurst-Villa Park-Lombard Water Commission, the Chicago Park District and the Metropolitan Sanitary District of Greater Chicago, their employees and agents and all persons assuming to act under their authority, are hereby enjoined from diverting any of the waters of Lake Michigan or its watershed into the Illinois waterway, whether by way of domestic pumpage from the lake the sewage effluent derived from which reaches the Illinois waterway, or by way of storm runoff from the Lake Michigan watershed which is diverted into the Sanitary and Ship Canal, or by way of direct diversion from the lake into the canal, in excess of an average for all of them combined of 3,200 cubic feet per second. "Domestic pumpage," as used in this decree, includes water supplied to commercial and industrial establishments, and "domestic use" includes use by such establishments. The water permitted by this decree to be diverted from Lake Michigan and its watershed may be apportioned by the State of Illinois among its municipalities, political subdivisions, agencies, and instrumentalities

Page 388 U. S. 428

for domestic use or for direct diversion into the Sanitary and Ship Canal to maintain it in a reasonably satisfactory sanitary condition, in such manner and amounts and by and through such instrumentalities as the State may deem proper, subject to any regulations imposed by Congress in the interests of navigation or pollution control.

2. The amount of water diverted into the Sanitary and Ship Canal directly from Lake Michigan and as storm runoff from the Lake Michigan watershed shall be determined by deducting from the total flow in the canal at Lockport (a) the total amount of domestic pumpage from Lake Michigan and from ground sources in the Lake Michigan watershed, except to the extent that any such ground sources are supplied by infiltration from Lake Michigan, by the State of Illinois and its municipalities, political subdivisions, agencies, and instrumentalities the sewage effluent derived from which reaches the canal, (b) the total amount of domestic pumpage from ground and surface sources outside the Lake Michigan watershed the sewage effluent derived from which reaches the canal, (c) the total estimated storm runoff from the upper Illinois River watershed reaching the canal, (d) the total amount of domestic pumpage from all sources by municipalities and political subdivisions of the States of Indiana and Wisconsin the sewage effluent derived from which reaches the canal, and (e) any water diverted by Illinois, with the consent of the United States, into Lake Michigan from any source outside the Lake Michigan watershed.

3. For the purpose of determining whether the total amount of water diverted from Lake Michigan by the State of Illinois and its municipalities, political subdivisions, agencies, and instrumentalities is not in excess of the maximum amount permitted by this decree, the amounts of domestic pumpage from the lake by the

Page 388 U. S. 429

State and its municipalities, political subdivisions, agencies, and instrumentalities the sewage and sewage effluent derived from which reaches the Illinois waterway, either above or below Lockport, shall be added to the amount of direct diversion into the canal from the lake and storm runoff reaching the canal from the Lake Michigan watershed computed as provided in paragraph 2 of this decree. The accounting period shall consist of the period of 12 months terminating on the last day of February. A period of five years, consisting of the current annual accounting period and the previous four such periods (all after the effective date of this decree), shall be permitted, when necessary, for achieving an average diversion which is not in excess of the maximum permitted amount; provided, however, that the average diversion in any annual accounting period shall not exceed one hundred ten (110) percent of the maximum amount permitted by this decree. The measurements and computations required by this decree shall be made by the appropriate officers, agencies, or instrumentalities of the State of Illinois under the general supervision and direction of the Corps of Engineers of the United States Army.

4.

The State of Illinois may make application for a modification of this decree so as to permit the

diversion of additional water from Lake Michigan for domestic use when and if it appears that the reasonable needs of the Northeastern Illinois Metropolitan Region (comprising Cook, Du Page, Kane, Lake, McHenry, and Will Counties) for water for such use cannot be met from the water resources available to the region, including both ground and surface water and the water permitted by this decree to be diverted from Lake Michigan, and if it further appears that all feasible means reasonably available to the State of Illinois and its municipalities, political subdivisions, agencies, and instrumentalities

Page 388 U. S. 430

have been employed to improve the water quality of the Sanitary and Ship Canal and to conserve and manage the water resources of the region and the use of water therein in accordance with the best modern scientific knowledge and engineering practice.

5. This decree shall become effective on March 1, 1970, and shall thereupon supersede the

decree entered by this Court in Nos. 1, 2, and 3, Original Docket, on April 21, 1930, as enlarged May 22, 1933, provided that, for the period between January 1, 1970, and March 1, 1970, the amount of water diverted by Illinois into the Sanitary and Ship Canal (determined in accordance with paragraph 2 of this decree) shall not exceed an average of 1,500 cubic feet per second.

6. The complaint of the State of Illinois in No. 11, Original Docket, on behalf of its

instrumentality, the Elmhurst-Villa Park-Lombard Water Commission, is hereby dismissed, without prejudice to that Commission sharing in the water permitted by this decree to be diverted from Lake Michigan.

7. Any of the parties hereto may apply at the foot of this decree for any other or further action or

relief, and this Court retains jurisdiction of the suits in Nos. 1, 2, and 3, Original Docket, for the purpose of making any order or direction, or modification of this decree, or any supplemental decree, which it may deem at any time to be proper in relation to the subject matter in

controversy.

8. All the parties to these proceedings shall bear their own costs. The costs and expenses of the

Special Master shall be equally divided between the plaintiffs as a group a