IVAN ALLEN CO. v. UNITED STATES
No. 74-22
Supreme Court of the United States
Argued April 14-15, 1975—Decided June 26, 1975
422 U.S. 617
Assistant Attorney General Crampton argued the cause for the United States. With him on the brief were Solicitor General Bork, Stuart A. Smith, and Elmer J. Kelsey.*
MR. JUSTICE BLACKMUN delivered the opinion of the Court.
Sections 531-537, inclusive, of the Internal Revenue Code of 1954, as amended,
The issue here is whether, in determining the application of § 533 (a), listed and readily marketable securities owned by the corporation and purchased out of its earnings and profits, are to be taken into account at their cost to the corporation or at their net liquidation value, that is, fair market value less the expenses of, and taxes resulting from, their conversion into cash.
I
The pertinent facts are admitted by the pleadings or are stipulated:
The petitioner, Ivan Allen Company (the taxpayer), is a Georgia corporation incorporated in 1902 and actively engaged in the business of selling office furniture, equipment, and supplies in the metropolitan Atlanta area. It files its federal income tax returns on the accrual basis and for the fiscal year ended June 30.
For its fiscal years 1965 and 1966, the taxpayer paid in due course the federal corporation income taxes shown on its returns as filed. Taxable income so reported was $341,045.82 for 1965 and $629,512.19 for 1966. App. 59, 84. During fiscal 1965 the taxpayer paid dividends consisting of cash in the amount of $48,945.30 and 870 shares
Throughout fiscal 1965 and 1966, the taxpayer owned various listed and unlisted marketable securities. Prominent among these were listed shares of common stock and listed convertible debentures of Xerox Corporation that, in prior years, had been purchased out of earnings and profits. Specifically, on June 30, 1965, the corporation owned 11,140 shares of Xerox common, with a cost of $116,701 and a then fair market value of $1,573,525, and $30,600 Xerox convertible debentures, with a cost to it of $30,625 and a then fair market value of $48,424. On June 30, 1966, the corporation owned 10,090 shares of Xerox common, with a cost of $102,479 and a then fair market value of $2,479,617, and the same $30,600 convertible debentures, with their cost of $30,625 and a then fair market value of $69,768. Id., at 55.
According to its returns as filed, the taxpayer‘s undistributed earnings as of June 30, 1965, and June 30, 1966, were $2,200,184.77 and $2,360,146.52, respectively. Id., at 70, 91. The taxpayer points out that the marketable portfolio assets represented an investment, as measured by cost, of less than 7% of its undistributed earnings and of less than 5% of its total assets. Brief for Petitioner 4.
It is also apparent, however, that the Xerox debentures and common shares had proved to be an extraordinarily profitable investment, although, of course, because these securities continued to be retained, the gains thereon were unrealized for federal income tax purposes. The debentures had increased in fair market value more than 50% over cost by the end of June 1965,
Throughout fiscal 1965 and 1966 the taxpayer‘s two major shareholders, Ivan Allen, Sr., and Ivan Allen, Jr., respectively owned 31.20% and 45.46% of the taxpayer‘s outstanding voting stock. App. 78, 104.
Following an examination of the taxpayer‘s federal income tax returns for fiscal 1965 and 1966, the Commissioner of Internal Revenue determined that the taxpayer had permitted its earnings and profits for each of those years to accumulate beyond the reasonable and reasonably anticipated needs of its business, and that one of the purposes of the accumulation for each year was to avoid income tax with respect to its shareholders. Based upon this determination, the Commissioner assessed against the corporation accumulated earnings taxes of $77,383.98 and $73,131.87 for 1965 and 1966, respectively.
The taxpayer paid these taxes and thereafter timely filed claims for refund. The claims were not allowed, and the taxpayer then instituted this refund suit in the United States District Court for the Northern District of Georgia.
It is agreed that the taxpayer had reasonable business needs for operating capital amounting to $1,198,309 and $1,455,222 at the close of fiscal 1965 and fiscal 1966, respectively. Id., at 56. It is stipulated, in particular, that if the taxpayer‘s marketable securities are to be taken into account at cost, its net liquid assets (current assets less current liabilities), at the end of each of those taxable years, and fully available for use in its business, were then exactly equal to its reasonable business needs for operating capital, that is, the above-stated figures of $1,198,309 and $1,455,222. It would follow, accordingly,
The issue, therefore, is clear and precise: whether, for purposes of applying § 533 (a), the taxpayer‘s readily marketable securities should be taken into account at cost, as the taxpayer contends, or at net liquidation value, as the Government contends.
The District Court held that the taxpayer‘s readily marketable securities were to be taken into account at cost. Accordingly, it entered judgment for the petitioner-taxpayer. 349 F. Supp. 1075 (1972). The court observed:
“Corporate taxpayers should not be penalized for
The United States Court of Appeals for the Fifth Circuit reversed. 493 F. 2d 426 (1974). It observed:
“[T]he securities involved in the case at bar are of such a highly liquid character as to be readily available for business needs that might arise. Thus the appreciated value of these securities should be taken into account when determining whether the corporation has accumulated profits in excess of reasonable business needs.
“This decision does not force the corporation to liquidate these securities at any time when a sale would be financially unwise, but only compels the corporation to comply with the proscriptions of the Code and refrain from accumulating excessive earnings and profits.” Id., at 428.
The case was remanded, as the parties had agreed, App. 57-58, “for the additional factual determination [under § 532 (a)] of whether one purpose for the accumulation was to avoid income tax on behalf of the shareholders.” 493 F. 2d, at 428.
Because this conclusion was claimed by the taxpayer to conflict in principle with American Trading & Production Corp. v. United States, 362 F. Supp. 801 (Md. 1972), aff‘d without published opinion, 474 F. 2d 1341 (CA4 1973),6 and because of the importance of the issue in the administration of the accumulated earnings tax, we granted certiorari. 419 U. S. 1067 (1974).
II
Under our system of income taxation, corporate earnings are subject to tax at two levels. First, there is the tax imposed upon the income of the corporation. Second, when the corporation, by way of a dividend, distributes its earnings to its shareholders, the distribution is subject to the tax imposed upon the income of the shareholders. Because of the disparity between the corporate tax rates and the higher gradations of the rates on individuals,7 a corporation may be utilized to reduce significantly its shareholders’ overall tax liability by accumulating earnings beyond the reasonable needs of the business. Without some method to force the distribution of unneeded corporate earnings, a controlling shareholder would be able to postpone the full impact of income taxes on his share of the corporation‘s earnings in excess of its needs. See B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders ¶ 8.01 (3d ed. 1971); B. Wolfman, Federal Income Taxation of Business Enterprise 864 (1971).
In order to foreclose this possibility of using the corporation as a means of avoiding the income tax on dividends to the shareholders, every Revenue Act since the adoption of the Sixteenth Amendment in 1913 has imposed a tax
The Court has acknowledged the obvious purpose of the accumulation provisions of the successive Acts:
“As the theory of the revenue acts has been to tax corporate profits to the corporation, and their receipt
only when distributed to the stockholders, the purpose of the legislation is to compel the company to distribute any profits not needed for the conduct of its business so that, when so distributed, individual stockholders will become liable not only for normal but for surtax on the dividends received.” Helvering v. Chicago Stock Yards Co., 318 U. S. 693, 699 (1943).
This was reaffirmed in United States v. Donruss Co., 393 U. S. 297, 303 (1969).
It is to be noted that the focus and impositions of the accumulated earnings tax are upon “accumulated taxable income,” § 531. This is defined in § 535 (a) to mean the corporation‘s “taxable income,” as adjusted. The adjustments consist of the various items described in § 535 (b), including federal income tax, the deduction for dividends paid, defined in § 561, and the accumulated earnings credit defined in § 535 (c). The adjustments prescribed by §§ 535 (a) and (b) are designed generally to assure that a corporation‘s “accumulated taxable income” reflects more accurately than “taxable income” the amount actually available to the corporation for business purposes. This explains the deductions for dividends paid and for federal income taxes; neither of these enters into the computation of taxable income. Obviously, dividends paid and federal income taxes deplete corporate resources and must be recognized if the corporation‘s economic condition is to be properly perceived. Conversely, § 535 (b) (3) disallows, for example, the deduction, available to a corporation for income tax purposes under § 243, on account of dividends received; dividends received are freely available for use in the corporation‘s business.
The purport of the accumulated earnings tax structure established by §§ 531-537, therefore, is to determine the
It is important to emphasize that we are concerned here with a tax on “accumulated taxable income,” § 531, and that the tax attaches only when a corporation has permitted “earnings and profits to accumulate instead of being divided or distributed,” § 532 (a). What is essential is that there be “income” and “earnings and profits.” This at once eliminates, from the measure of the tax itself, any unrealized appreciation in the value of the taxpayer‘s portfolio securities over cost, for any such unrealized appreciation does not enter into the computation of the corporation‘s “income” and “earnings and profits.”
The corporation‘s readily marketable portfolio securities and their unrealized appreciation, nonetheless, are of profound importance in making the entirely discrete determination whether the corporation has permitted what, concededly, are earnings and profits to accumulate beyond its reasonable business needs. If the securities, as here, are readily available as liquid assets, then the recognized earnings and profits that have been accumulated may well have been unnecessarily accumulated, so far as the reasonable needs of the business are concerned. On the other hand, if those portfolio securities are not liquid and are not readily available for the needs of the business, the accumulation of earnings and profits may be viewed in a different light. Upon this analysis, not only is such accumulation as has taken place important, but the liquidity otherwise available to the corporation is highly significant. In any event—and we repeat—the tax is directed at the accumulated taxable income and
Accumulation beyond the reasonable needs of the business, by the language of § 533 (a), is “determinative of the purpose” to avoid tax with respect to shareholders unless the corporation proves the contrary by a preponderance of the evidence. The burden of proof, thus, is on the taxpayer. A rebuttable presumption is statutorily imposed. To be sure, we deal here, in a sense, with a state of mind. But it has been said that the statute, without the support of the presumption, would “be practically unenforceable....” United Business Corp. v. Commissioner, 62 F. 2d 754, 755 (CA2), cert. denied, 290 U. S. 635 (1933). What is required, then, is a comparison of accumulated earnings and profits with “the reasonable needs of the business.” Business needs are critical. And need, plainly, to use mathematical terminology, is a function of a corporation‘s liquidity, that is, the amount of idle current assets at its disposal. The question, therefore, is not how much capital of all sorts, but how much in the way of quick or liquid assets, it is reasonable to keep on hand for the business. United Block Co. v. Helvering, 123 F. 2d 704, 705 (CA2 1941), cert. denied, 315 U. S. 812 (1942); Smoot Sand & Gravel Corp. v. Commissioner, 274 F. 2d 495, 501 (CA4), cert. denied, 362 U. S. 976 (1960) (liquid assets provide “a strong indication” of the purpose of the accumulation); Electric Regulator
The taxpayer itself recognizes, and accepts, the liquidity concept as a basic factor, for it “has agreed that the full amount of its realized earnings invested in its liquid assets—their cost—should be taken into account in determining the applicability of Section 533 (a).” Brief for Petitioner 15. It concedes that if this were not so, “the tax could be avoided by any form of investment of earnings and profits.” Reply Brief for Petitioner 5. But the taxpayer would stop at the point of cost and, when it does so, is compelled to compare earnings and profits—not the amount of readily available liquid assets, net—with reasonable business needs.
We disagree with the taxpayer and conclude that cost is not the stopping point; that the application of the accumulated earnings tax, in a given case, may well depend on whether the corporation has available readily marketable portfolio securities; and that the proper measure of those securities, for purposes of the tax, is their net realizable value. Cost of the marketable securities on the assets side of the corporation‘s balance sheet would appear to be largely an irrelevant gauge of the taxpayer‘s true financial condition.10 Certainly, a
lender would not evaluate a potential borrower‘s marketable securities at cost. Realistic financial condition is the focus of the lender‘s inquiry. It also must be the focus of the Commissioner‘s inquiry in determining the applicability of the accumulated earnings tax.11
This taxpayer‘s securities, being liquid and readily marketable, clearly were available for the business needs of the corporation, and their fair market value, net, was such that, according to the stipulation, the taxpayer‘s undistributed earnings and profits for the two fiscal years in question were permitted to accumulate beyond the reasonable and reasonably anticipated needs of the business.
III
Bearing directly upon the issue before us is Helvering v. National Grocery Co., 304 U. S. 282 (1938). There the fact situation was the reverse of the present case inasmuch as that taxpayer corporation had unrealized losses in the value of marketable securities it was continuing to hold. After the Court upheld the accumulated earnings tax against constitutional attack, id., at
The precedent of National Grocery has been applied in accumulated earnings tax cases, with courts taking into account the fair market value of liquid, appreciated securities. Battelstein Investment Co. v. United States, 442 F. 2d 87, 89 (CA5 1971); Cheyenne Newspapers, Inc. v. Commissioner, 494 F. 2d 429, 434-435 (CA10 1974); Henry Van Hummell, Inc. v. Commissioner, 23 T. C. M. 1765, 1779 (1964), aff‘d, 364 F. 2d 746 (CA10 1966), cert. denied, 386 U. S. 956 (1967); Golconda Mining Corp. v. Commissioner, 58 T. C. 139, supplemental opinion, 58 T. C. 736, 737-739 (1972), rev‘d on other grounds, 507 F. 2d 594 (CA9 1974); Ready Paving & Constr. Co. v. Commissioner, 61 T. C. 826, 840-841 (1974). But see Harry A. Koch Co. v. Vinal, 228 F. Supp. 782, 784 (Neb. 1964).
American Trading & Production Corp. v. United States, 362 F. Supp. 801 (Md. 1972), aff‘d without pub-
Whatever may be the merit or demerit of the other grounds asserted by the District Court in American Trading—and we express no view thereon—we are satisfied that the court‘s determination as to the absence of ready salability, under all the circumstances, provides a sufficient point of distinction of that case from this one, so that it provides meager, if any, contrary precedent of substance to our conclusion here.
IV
The arguments advanced by the taxpayer do not persuade us:
1. The taxpayer, of course, quite correctly insists that
As has been pointed out, the tax is imposed only upon accumulated taxable income, and this is defined to mean taxable income as adjusted by factors that have been described. The question is not whether unrealized appreciation enters into the determination of earnings and profits, which it does not, but whether the accumulated taxable income, in the determination of which earnings and profits have entered, justifiably may be retained rather than distributed as dividends. The tax focuses, therefore, on current income and its retention or distribution. If the corporation has freely available liquid assets in excess of its reasonable business needs, then accumulation of taxable income may be unreasonable and the tax may attach. Utilizable availability of the portfolio assets is measured realistically only at net realizable value. The fact that this value is not included in earnings and profits does not foreclose its being considered in determining whether the corporation is subject to the accumulated earnings tax.
2. We see nothing in the “realization of income” concept of Eisner v. Macomber, 252 U. S. 189 (1920), that has significance for the issue presently under consideration. There the Court held that a dividend of common shares issued by a corporation having only common outstanding was not includable in the shareholder‘s gross income for income tax purposes. The decision may have prompted the shift, noted above and effected by the Revenue Act of 1921, of the incidence of the accumulated
3. The taxpayer also argues that the effect of the Court of Appeals decision is to force the taxpayer to convert its appreciated assets in order to meet its business needs. It suggests that management should be entitled to finance business needs without resorting to unrealized appreciation. The argument, plainly, goes too far. On the taxpayer‘s own theory that marketable securities may be taken into account at their cost, a situation easily may be imagined where some conversion into cash becomes necessary, if the corporation is to avoid the accumulated earnings tax.
That our decision does not interfere with corporate management‘s exercise of sound business judgment, and that it does not amount to a dictation to management as to when appreciated assets are to be liquidated, was aptly answered by the Court of Appeals:
“This decision does not force the corporation to liquidate these securities at any time when a sale would be financially unwise, but only compels the corporation to comply with the proscriptions of the Code and refrain from accumulating excessive earnings and profits. That taxpayer, as a consequence of its own sound judgment in making profitable investments, must sell, exchange or distribute to the shareholders assets in order to avoid an excessive accumulation of earnings and thus comply with the Code‘s
requirements is no justification for precluding its application.” 493 F. 2d, at 428.
We might add that the existence of the Code‘s provisions for the accumulated earnings tax, of course, will affect management‘s decision. So, too, does the very existence of the corporate income tax itself. In this respect, the one is no more offensive than the other. Astute management in these tax-conscious days is not that helpless, and shrinkage, upon liquidation, of one-fourth of the appreciation hardly equates with loss. Such business decision as is necessitated was expressly intended by the Congress. All that is required is the disgorging, at the most, of the taxable year‘s “accumulated taxable income.”
4. It is no answer to suggest that our decision here may conflict with standard accounting practice. The Court has not hesitated to apply congressional policy underlying a revenue statute even when it does conflict with an established accounting practice. See, e. g., Schlude v. Commissioner, 372 U. S. 128 (1963); American Automobile Assn. v. United States, 367 U. S. 687, 692-694 (1961). It is of some interest that the taxpayer itself, for the tax years under consideration, reflected the market value as well as the cost of its marketable securities on its balance sheets. App. 112, 118. This appears to be in line with presently accepted practice. See R. Kester, Advanced Accounting 117-118, 122-124 (4th ed. 1946).
The judgment of the Court of Appeals is affirmed.
It is so ordered.
MR. JUSTICE POWELL, with whom MR. JUSTICE DOUGLAS and MR. JUSTICE STEWART join, dissenting.
The Court‘s decision departs significantly from the relevant statutory language, creates a rule of additional
I
Petitioner, a corporation with 34 stockholders, is engaged in selling office supplies and equipment. In the late 1950‘s, because petitioner was a retail outlet for equipment of the Xerox Corp., it invested $147,000 of its earnings and profits in securities of Xerox. The market value of that investment increased substantially over the years, and by the end of petitioner‘s 1965 and 1966 tax years the unrealized market appreciation1 of those securities approximated $1,475,000 and $2,416,000 respectively.2 For the purpose of determining the applicability of the additional penalty tax liability under
The question is one of statutory construction: In determining whether a corporation has accumulated earnings and profits in excess of reasonable business needs within the meaning of
II
I address first the statutory language, which in my view is controlling.
The central element of this statutory scheme is the unreasonable accumulation of earnings and profits beyond the corporation‘s reasonable needs. It is stipulated in this case that there is no unreasonable accumulation and no additional tax unless the unrealized appreciation of the Xerox securities is added to petitioner‘s actual accumulated earnings and profits (i. e., to its earned sur-
In view of this unanimity of law and practice, what theory is devised by the Government and the Court today as justification for a different rule for this penalty tax? I look to the Court‘s opinion for the answer. It is conceded that “unrealized appreciation does not enter into the computation of the corporation‘s... [accumulated] ‘earnings and profits.‘” Ante, at 627. Neverthe-
The statute provides no basis whatever for this distinction. According to its own terms, selected with full knowledge of accepted tax and accounting principles, the penalty tax applies only if there is an unreasonable accumulation of earnings and profits; the statute contains no reference to the addition of unrealized appreciation to the accumulated earnings and profits which constitute the only basis for imposing the tax. Nor does the history or purpose of the statute support the “add on” of an unrealized increment of value conceded by the Court to be neither earnings nor profits. By authorizing this “add on,” the Court‘s decision effectively converts the tax on excessive accumulation of earnings and profits to a tax on the retention of certain assets that appreciate in value. Although current accumulated taxable income remains the measure of the tax, its application in many cases will be controlled simply by the existence of unrealized appreciation in the value of these assets.
The purpose of the statute, as the Court states, is “to force the distribution of unneeded corporate earnings.” Ante, at 624. Such a distribution is accomplished by the payment of dividends, which normally are declared and paid only out of current earnings or earned surplus, determined in accordance with sound accounting practice. Absent authorization in a statute or corporate charter, corporate directors who pay dividends from unrealized
III
The plain language of the Code resolves this case for me. But even if the statute could be thought ambigu-
Businesses normally are conducted, and management decisions made, on the basis of financial information that is maintained in accordance with sound accounting practice. The most elementary principle of accounting practice is that assets are recorded at cost. This is true with respect to the computation of earnings and profits, payment of ordinary corporate taxes, determination of dividend policy, and reporting to stockholders, the SEC, and other regulatory agencies. Corporate books and records are audited only on that basis. Whatever may be said for the Court‘s view of the “unreality” of adhering to the principles of sound accounting practice, ante, at 629-630, those principles are the best system yet devised for guiding management, informing shareholders, and determining tax liability. They have the not inconsiderable virtues of consistency, regularity, and certainty—virtues that also assure fairness and reasonable
The Court today abandons accounting principles confirmed by the wisdom of business experience and announces a new rule with far-reaching consequences. In my view, this rule will create uncertainty and open wide possibilities for unfairness.
A
Both taxpayers and the Government know what is meant by “cost basis,” and a corporation‘s earned surplus account, which reflects accumulated earnings and profits from which dividends normally are paid, is an established accounting fact. There is no comparable certainty or dependability in the rule devised by the Court:
“Cost of the marketable securities on the assets side of the corporation‘s balance sheet would appear to be largely an irrelevant gauge of the taxpayer‘s true financial condition. Realistic financial condition is the focus... of the Commissioner‘s inquiry in determining the applicability of the accumulated earnings tax.” Ante, at 629-630 (emphasis added).
In this case, involving marketable securities, the computation of the true value for purposes of the tax appears at first blush to present no serious problem of uncertainty. The Court simply equates market price at the end of the tax year with true value, and adds the resulting excess over cost to the book value of the securities. Apart from the questionable assumption that market quotations represent the true value of a retained common stock, the Court‘s new formulation poses perplexing definitional questions for management.
An initial uncertainty results from the Court‘s ambiguous use of the term “securities.” As defined in the
In addition, uncertainties will arise in ascertaining whether the asset is sufficiently “readily marketable” to satisfy the Court‘s test. The Court attaches significance to whether the security is “listed” on a stock exchange. It is indeed true that the great majority of common stocks listed on the New York Stock Exchange are readily marketable, unless the number of shares to be sold is too large for the market to absorb. The same cannot be said, however, of all bonds listed on that Exchange. Moreover, there are other exchanges on which securities are listed and traded: the American Stock Exchange, over the counter, and scores of local exchanges. While many securities traded on these exchanges may be “readily marketable,” perhaps the majority could not fairly be so characterized. In countless situations corporate management will be unable to determine, short of attempting to sell the security, whether it is “readily marketable” or not.
The uncertainty engendered by today‘s opinion will not be limited to its undifferentiated treatment of marketable securities. A more fundamental question arising from the rationale of the Court‘s decision is whether the test of “true” or “realistic” financial condition will be applied to other assets. Nothing in the relevant statutory provisions suggests a distinction between securities and other assets, or even between assets with varying degrees of marketability. The Court nevertheless appears to read into the statutes a distinction based on “liquidity,” at various points referring interchangeably to “readily marketable securities,” “current assets,” and “quick or liquid assets.” Ante, at 622, 628. Although the Court‘s holding is limited in this case to readily marketable securities, see ante, at 629 n. 9, its rationale is not so easily contained.
The Court states categorically that the “focus” of the Commissioner‘s inquiry, in determining the application of this tax, must be on what it calls true or realistic financial condition. Ante, at 629-630. In view of this postulation, and the absence of any distinction in the statute among types of assets, is the Commissioner now free to include in his computation the unrealized appreciation of all corporate assets? Once cost basis is abandoned, and “realistic” value becomes the standard, the uncertainties confronting prudent management in many cases will be profoundly disquieting. To be sure, read narrowly, the Court‘s decision applies only to readily marketable securities, with emphasis on “liquidity.” But this is another relative term, depending on the nature of the asset and the uncertainties of market conditions at the time.
The potential sweep of the Court‘s decision is forecast by the response of Government counsel to questions
The types of assets in which corporations lawfully may invest earnings and profits embrace the total range of property interests. They include, to name only a few examples, unimproved real estate within the anticipated growth pattern of a major urban area, improved real estate, unlisted securities of growth corporations that have not “gone public,” undivided interests in oil or mining ventures, and even objects of art. At various times and depending upon conditions, any of these assets may be viewed as—and in fact may be—readily marketable and therefore “liquid.” The unrealized appreciation of such assets may well bear upon the realistic financial condition of a corporation, however it is defined. In light of these economic facts, the sweep of today‘s decision presents problems both for corporate taxpayers and the Government.9
C
I further think that the Court‘s decision to attach significant tax consequences to the market price of a volatile stock at a particular point in time will lead to unfairness in the application of the accumulated earnings tax. The Court‘s net liquidation formulation seems to assume, and nothing in the opinion dispels this assumption, that readily marketable assets are to be valued as of the end of the tax year in question. Moreover, the Court apparently would treat all marketable securities the same for the purpose of this valuation. No distinction is drawn or even suggested among the wide variety of securities that are held as corporate assets.
The market price of a short-term Treasury note, at most only fractionally different from its cost basis, would represent its value under any test. But few financial analysts or economists would say that the market quotation of a common stock at any particular time necessarily
Bearing in mind the actual variations in the price of
By departing from the cost-basis standard of sound accounting practice, and compelling reliance on an isolated market price of a retained common stock, the Court itself departs from its avowed goal of “economic reality.” Ante, at 627. An average price range at which the stock might have been sold over a relatively long period might produce a more equitable result in some cases. It would not, however, alleviate the basic problem inherent in the Court‘s formulation. The taxpayer still could be penalized for having failed to consider, in planning future business needs, the highly ephemeral “value” of unrealized appreciation on common stock. The effect of today‘s decision is to hold business management accountable for unrealized appreciation as if it were cash in hand, probably forcing corporate management in many cases to liquidate securities that otherwise it would have elected to retain.11
Management decisions during the course of a year, including decisions whether and when to pay dividends and in what amounts, cannot be made intelligently on the basis of an asset so volatile that it may depreciate in market value as much as 8% in a single day and 61% in a year. Uncertainty of this magnitude could only be avoided by liquidation of assets that have appreciated in value. I find nothing in the language or purpose of this tax that justifies such detrimental interference with sound corporate management.
IV
The Court places major reliance on Helvering v. National Grocery Co., 304 U. S. 282 (1938), finding that that opinion “forecloses the present taxpayer‘s case.” Ante, at 631. I respectfully suggest that the Court‘s interpretation of National Grocery will not withstand close scrutiny of the facts or its actual holding.12
“Depreciation in any of the assets is evidence to be considered by the Commissioner and the Board in determining the issue of fact whether the accumulation of profits was in excess of the reasonable needs of the business. But obviously depreciation in the market value of securities which the corporation continues to hold does not, as matter of law, preclude a finding that the accumulation of the year‘s profits was in excess of the reasonable needs of the business.” 304 U. S., at 291.
When National Grocery is read in light of the facts and issues there presented—as it must be in order to understand the Court‘s passing statement—it is readily apparent that the holding in that case does not govern the issue here. The central issue there was the
I therefore find no justification for the view that National Grocery forecloses consideration of the question here presented. Moreover, even if I could agree with the Court‘s interpretation of that case, I would refuse to follow a rationale so plainly at odds with the statutory language and so conducive to uncertainty and unfairness.
V
The uncertainties the Court has now read into this penal statute correspondingly vest in the Internal Revenue Service an inappropriate latitude in its administration. In light of today‘s decision, the Commissioner will have wide and virtually uncontrolled discretion in deciding which corporations will be subject to additional taxation, or at least in deciding which will be required to rebut the presumption that earnings were accumulated to evade shareholder tax liability. Until today‘s decision, management, in trying to anticipate what a Commissioner would deem an unreasonable accumulation, at least could rely on the corporation‘s earned surplus account as establishing its accumulated earnings and profits. Now this dependable benchmark has become an “irrelevant gauge” of a corporation‘s “true financial con-
The volatility and transient character of market prices of a common stock are illustrated by the following tables:*
TABLE I
XEROX CORP. COMMON STOCK†
| High | Low | % Change High to Low | |
|---|---|---|---|
| Fluctuations in a single day: | |||
| June 14, 1965 | 48.25 | 45 | - 6.7 |
| May 16, 1975 | 87 | 78.50 | - 9.8 |
| Fluctuations in a single month: | |||
| November 1965 | 66.50 | 57.50 | -13.6 |
| August 1974 | 98 | 74.25 | -24.2 |
| Fluctuations in a single year: | |||
| 1965 | 71 | 31 | -56.3 |
| 1974 | 127 | 49 | -61.4 |
*Except as noted, all data in this Appendix were taken from published New York Stock Exchange quotations. The information presented here is selective and presented for illustrative purposes.
†All Xerox quotations take into account the 1965 three-for-one split.
TABLE II
SELECTED STOCK RANGES DURING 1965*
| Name of Company | High | Low | Close | Change Open to Close | Percent Change High to Low | Percent Change Open to Close |
|---|---|---|---|---|---|---|
| Chrysler Corp. | 62 1/4 | 41 5/8 | 53 3/8 | - 7 5/8 | -33.1% | - 12.5% |
| Fairchild Camera. | 165 1/4 | 27 1/4 | 150 1/2 | +123 | -83.5% | +447.3% |
| Financial Federation. | 37 1/4 | 19 5/8 | 23 7/8 | - 13 1/8 | -47.3% | - 35.5% |
| General Dynamics. | 68 1/4 | 35 | 56 3/4 | + 21 3/4 | -48.7% | + 62.1% |
| W. T. Grant. | 62 1/4 | 35 7/8 | 62 1/4 | + 25 3/4 | -42.4% | + 70.5% |
| Grolier, Inc. | 60 1/2 | 37 | 55 3/4 | - 1/4 | -38.8% | - 1/2% |
| Gulf & Western Ind. | 102 | 31 1/8 | 92 7/8 | + 61 1/8 | -69.5% | +192.5% |
| KLM Airlines. | 81 7/8 | 19 3/4 | 79 | + 59 | -75.9% | +295.0% |
| Ling Tempco Vaught. | 58 | 17 1/4 | 48 1/4 | + 30 3/4 | -70.3% | +175.7% |
| Pan American Airways. | 55 5/8 | 25 1/4 | 51 3/8 | + 22 5/8 | -54.6% | + 79.4% |
| Pennsylvania Railroad. | 65 | 35 1/8 | 64 3/8 | + 25 3/4 | -46.0% | + 66.7% |
| Polaroid Corp. | 130 | 44 1/4 | 116 5/8 | + 70 3/4 | -66.0% | +154.2% |
| RCA Corp. | 50 1/2 | 31 | 47 1/4 | + 13 3/8 | -38.6% | + 39.5% |
| United Airlines. | 118 5/8 | 58 5/8 | 104 3/4 | + 45 1/2 | -50.6% | + 76.8% |
| White Consolidated Ind. | 49 1/2 | 17 3/8 | 48 3/4 | + 30 3/4 | -64.9% | +170.8% |
| Xerox Corp. | 215 | 94 7/8 | 202 | +103 3/8 | -55.9% | +104.8% |
| 12/31/64 | High | Low | 12/31/65 | |
|---|---|---|---|---|
| Dow Jones Industrial Average | 874.13 | 969.26 | 840.59 | 969.26 |
| Percent Change High to Low | -13.3% | |||
| Standard & Poor‘s 500 Index | 84.75 | 92.63 | 81.60 | 92.43 |
| Percent Change High to Low | -11.9% |
SOME PRICES AS OF MAY 12, 1975, OF SELECTED COMPANIES LISTED ABOVE†
| Chrysler Corp. | 12 1/4 | |
| W. T. Grant. | 1/4 | |
| Grolier, Inc. | 6 | (Adjusted for 2 for 1 Split—1966) |
| Pan American Airways. | 5 1/2 | (Adjusted for 2 for 1 Split—1966) |
| Pennsylvania Central. | 1 5/8 | (Adjusted for 2 for 1 Split—1967) |
| Polaroid Corp. | 63 1/4 | (Adjusted for 2 for 1 Split—1968) |
| RCA Corp. | 17 3/4 | |
| UAL, Inc. (United Airlines) | 42 | (Adjusted for 2 for 1 Split—1966) |
| Xerox Corp. | 258 3/4 | (Adjusted for 3 for 1 Split—1969) |
*Source—New York Times—Monday, January 17, 1966—for stock ranges only.
†Prices have been adjusted for additional shares received as a result of stock splits.
TABLE III
SELECTED STOCK RANGES DURING 1974*
| Name of Company | High | Low | Close | Change Open to Close | Percent Change High to Low | Percent Change Open to Close |
|---|---|---|---|---|---|---|
| ACF Industries. | 61 1/4 | 28 3/4 | 33 | -24 7/8 | -53.0% | - 43.0% |
| Addressograph-Multigraph | 11 3/4 | 3 | 3 3/8 | - 6 1/2 | -74.5% | - 65.8% |
| Citizens & Southern Realty. | 31 3/4 | 2 | 2 5/8 | -26 3/4 | -93.7% | - 91.1% |
| Chrysler Corp. | 20 1/8 | 7 | 7 1/4 | - 8 3/8 | -65.2% | - 53.6% |
| Coca Cola Co. | 127 3/4 | 44 5/8 | 53 | -73 1/2 | -65.1% | - 58.1% |
| Combustion Engineering. | 106 1/4 | 21 5/8 | 26 1/4 | -78 3/4 | -79.6% | - 75.0% |
| Consolidated Edison. | 21 1/2 | 6 | 7 1/2 | -11 1/4 | -72.1% | - 60.0% |
| Continental Illinois Corp. | 59 1/4 | 23 1/4 | 26 5/8 | -25 1/4 | -60.8% | - 48.7% |
| Cousins Mortgage. | 23 3/4 | 1 1/8 | 1 3/8 | -18 7/8 | -95.3% | - 93.2% |
| E. I. duPont. | 179 | 84 1/2 | 92 1/4 | -66 3/4 | -52.8% | - 42.0% |
| Eastman Kodak. | 117 1/2 | 57 5/8 | 62 7/8 | -53 1/8 | -51.0% | - 45.8% |
| Fidelity Mtge. Invest. | 10 1/4 | 9/16 | 15/16 | - 5 15/16 | -94.5% | - 86.4% |
| Foster Wheeler. | 64 1/2 | 13 | 15 3/8 | -45 | -79.8% | - 74.8% |
| Holly Sugar. | 39 | 12 1/8 | 26 1/4 | +13 3/4 | -68.9% | +110.0% |
| Honeywell, Inc. | 86 1/4 | 17 1/2 | 21 | -49 1/8 | -79.7% | - 70.1% |
| Name of Company | High | Low | Close | Change Open to Close | Percent Change High to Low | Percent Change Open to Close |
|---|---|---|---|---|---|---|
| Moore McCormack Resources. | 34 1/4 | 12 3/8 | 28 1/2 | +15 3/4 | -63.9% | +123.5% |
| RCA Corp. | 21 1/2 | 9 1/4 | 10 3/4 | - 7 3/4 | -57.0% | - 41.9% |
| Stone & Webster. | 89 7/8 | 31 1/2 | 33 3/8 | -56 | -65.0% | - 62.7% |
| Tri South Mtge. Investors. | 27 1/4 | 2 | 2 3/4 | -21 3/8 | -92.7% | - 88.5% |
| Union Camp Corp. | 63 | 37 1/4 | 38 7/8 | -20 3/8 | -40.9% | - 34.4% |
| Union Carbide. | 46 | 31 3/4 | 41 3/8 | + 7 1/4 | -31.0% | + 21.3% |
| Xerox Corp. | 127 1/4 | 49 | 51 1/2 | -71 1/4 | -61.5% | - 58.0% |
| Great Western United. | 31 1/4 | 3 1/8 | 24 1/4 | +20 3/4 | -90.0% | +592.9% |
| Great American Mortgages. | 32 | 1 | 1 1/8 | -28 7/8 | -96.8% | - 96.3% |
RANGE IN AVERAGES
| 12/31/73 | High | Low | 12/31/74 | |
|---|---|---|---|---|
| Dow Jones Industrial Average | 850.86 | 891.66 | 577.60 | 616.24 |
| Percent Change High to Low | -35.2% | |||
| Standard & Poor‘s 500 Index | 97.55 | 99.80 | 62.28 | 68.24 |
| Percent Change High to Low | -37.6% |
*Source—Richmond Times-Dispatch, Sunday, Jan. 5, 1975, pp. E-6, E-7—for stock ranges only.
TABLE IV
WALL STREET JOURNAL
Friday, May 16, 1975, p. 33
Daily Percentage Leaders On N. Y. Stock Exchange
NEW YORK—The following list shows the stocks that have gone up the most and down the most based on percent of change on the New York Stock Exchange regardless of volume for Thursday. Net and percentage changes are the difference between the previous closing price and yesterday‘s last price.
UPS
| Name | Sales (hds) | High | Low | Last | Net | Pct. | |
|---|---|---|---|---|---|---|---|
| 1 | Welbilt Cp...... | 56 | 1 1/4 | 1 | 1 1/4 | + 1/4 Up | 25.0 |
| 2 | Int T&T pfF.... | 1 | 68 | 68 | 68 | + 8 Up | 13.3 |
| 3 | IDS Rlty Tr.... | 293 | 5 3/8 | 4 7/8 | 5 3/8 | + 5/8 Up | 13.2 |
| 4 | Centrn Data.... | 811 | 19 1/2 | 17 5/8 | 18 5/8 | + 1 3/4 Up | 10.4 |
| 5 | Texfi Ind...... | 13 | 5 3/8 | 5 1/4 | 5 3/8 | + 1/2 Up | 10.3 |
| 6 | Heler Int pf.... | 2 | 121 1/4 | 121 1/4 | 121 1/4 | +11 1/4 Up | 10.2 |
| 7 | CCI Corp...... | 9 | 1 1/2 | 1 1/2 | 1 1/2 | + 1/8 Up | 9.1 |
| 8 | Royal Ind...... | 150 | 4 7/8 | 4 1/2 | 4 5/8 | + 3/8 Up | 8.8 |
| 9 | Readg Co....... | 58 | 3 1/4 | 3 1/8 | 3 1/8 | + 1/4 Up | 8.7 |
| 10 | Rockower | 50 | 9 5/8 | 8 3/4 | 9 1/2 | + 3/4 Up | 8.6 |
DOWNS
| Name | Sales (hds) | High | Low | Last | Net | Pct. | |
|---|---|---|---|---|---|---|---|
| 1 | Falstaff | 178 | 4 | 3 3/8 | 3 3/8 | - 7/8 Off | 20.6 |
| 2 | SeabCst Lin..... | 2825 | 24 3/8 | 22 5/8 | 23 3/4 | - 4 5/8 Off | 16.3 |
| 3 | Emp 4.75pf..... | z100 | 4 1/4 | 4 1/4 | 4 1/4 | - 5/8 Off | 12.8 |
| 4 | Bulova Wat..... | 77 | 8 1/2 | 7 1/2 | 7 1/2 | - 1 Off | 11.3 |
| 5 | LehVallnd | 32 | 1 1/4 | 1 1/8 | 1 1/8 | - 1/8 Off | 10.0 |
| 6 | Adams Drg..... | 116 | 3 7/8 | 3 1/2 | 3 1/2 | - 3/8 Off | 9.7 |
| 7 | Benguet B...... | 226 | 2 3/4 | 2 1/2 | 2 1/2 | - 1/4 Off | 9.1 |
| 8 | ChaseMTr | 325 | 4 1/8 | 3 3/4 | 3 3/4 | - 3/8 Off | 9.1 |
| 9 | Plan Resrch..... | 212 | 4 3/8 | 3 7/8 | 3 7/8 | - 3/8 Off | 8.8 |
| 10 | Xerox Cp....... | 3350 | 87 | 78 1/2 | 78 5/8 | - 7 5/8 Off | 8.8 |
Notes
See 11 W. Fletcher, Cyclopedia of the Law of Private Corporations §§ 5329, 5329.1, 5335, 5335.1 (1971). Some States have statutes expressly prohibiting recognition of unrealized appreciation as a source upon which a corporation can rely in determining the amount of a dividend that legally can be paid. E. g.,
Georgia‘s law follows the Model Business Corporation Act, allowing payment of cash or property dividends only out of earned surplus or current earnings.
The basic facts of National Grocery are not fully revealed in this Court‘s opinion, but must be obtained from the opinions of the Board of Tax Appeals, 35 B. T. A. 163 (1936), the Court of Appeals for the Third Circuit, 92 F. 2d 931 (1937), and the briefs filed in this Court by the parties. In addition to those set forth above, the following are relevant: the decline in market value of the taxpayer‘s listed securities in the fiscal year aggregated $943,500; the $2,000,000 shrinkage figure mentioned by this Court included, in addition, the taxpayer‘s attempted elimination of $1,068,000 cost value of bank stocks claimed to be wholly unmarketable. Brief for Respondent in No. 723, O. T. 1937, pp. 34-35. In addition, as appears from the opinion of the Court of Appeals, National Grocery also claimed “that [its] merchandise shrank in value well on to a quarter million dollars, and the real estate declined in value $125,000.” 92 F. 2d, at 933. All of this alleged depreciation and shrinkage was claimed to have occurred in the taxable year, and was sought to be offset against net earnings for that year.