Wiegand et al. v. Commissioner of Internal Revenue, 194 F.2d 479 (3d Cir. 1952)

The petitioners comprise all the stockholders of the Wiegand Company, save two (the Tourtelots, whose tax case was decided in their favor, Tourtelot v. Commissioner of Internal Revenue, 7 Cir., 1951, 189 F.2d 167, and they seek a review of a decision of the Tax Court, 14 T.C. 136, which confirmed assessments of deficiencies against them by reason of stock dividends declared by Wiegand Company in June, 1940. The respective interests of the petitioners, their contentions and those of the Commissioner, are so fully set out in the opinions of the Tax Court and of its concurring and dissenting judges that they need not be repeated in detail here.

Under the dividend resolution shares of A and B stock (the only classes of stock) of the Company were issued pro rata among the stockholders so that for each share of A stock held a dividend of ½ share of A was allotted and for each share of B, ½ share of B. Appropriate amounts were transferred from the Company's surplus account to its capital account. Prior to the distributions the Company had outstanding 4,000 shares of A and 24,000 shares of B, a ratio of 1 A share to 6 B shares. After the distributions there were outstanding 6,000 shares of A and 36,000 shares of B, or the same ratio. All the voting power was held by the A stock before distribution and remained in the A following the dividend. No change was worked in the qualifications and preferences of the two classes of stock. These are as set out in the margin.¹ 

Some of the stockholders held both A and B stock. Some held only B. One stockholder held only A. The respective holdings both before and after distribution are set out on pages 139-140 of 14 T.C. There is no doubt but that the Company was and is a prosperous and going concern able to meet its dividend requirements or liquidation obligations.

We are of course concerned here with the "proportional interest" doctrine of taxation. It is based on the principle that when the tax-paying stockholder receives a stock dividend which does not alter his legal rights he does not incur the incidence of "income" taxation within the purview of the Sixteenth Amendment.²  The "proportional interest" doctrine is at least as old as Eisner v. Macomber, 1920, 252 U.S. 189, 40 S. Ct. 189, 64 L. Ed. 521. Its sources are apparent in Brushaber v. Union Pacific R. Co., 1916, 240 U.S. 1, 36 S. Ct. 236, 60 L. Ed. 493 and Towne v. Eisner, 1918, 245 U.S. 418, 38 S. Ct. 158, 62 L. Ed. 372, its fundamental principle being there stated by Mr. Justice Holmes as follows: "In short, the corporation is no poorer and the stockholder is no richer than they were before [the stock dividend]." Id., 245 U.S. at page 426, 38 S. Ct. at page 159. The doctrine has continued through Koshland v. Helvering, 1936, 298 U.S. 441, 56 S. Ct. 767, 80 L. Ed. 1268, Helvering v. Griffiths, 318 U.S. 371, 63 S. Ct. 636, 87 L. Ed. 843, and Helvering v. Sprouse, 1943, 318 U.S. 604, 63 S. Ct. 791, 87 L. Ed. 1029. It is a closed circle doctrine, the theory of retention of capital within the fictional corporate entity, when perhaps the burgeoning of a modern corporation might be more realistically represented by a mathematical symbol n, the stockholders being deemed to receive valuable additional choses as their corporation's assets increase.

In this case, after the distribution, 2,000 more shares of A stock possessed fixed preferences both in dividends and in liquidation; 12,000 more shares of B stock gave increased rights to dividends and in payments on liquidation to the B class before there could be any additional participation by both classes in dividends or on liquidation. See note 1, supra. These were practical, money-wise changes as distinguished from alterations of rights. No changes whatsoever were effected in the strict legal rights of stockholders either vis-a-vis each other or the corporation.³ 

The Supreme Court has decided where the proportional interest of the stockholders remains the same and where stock dividends are paid strictly in kind, where there is no severance of capital, that the incidence of income taxation does not occur. Cf. Rottschaefer, Present Taxable Status of Stock Dividends in Federal Law, 28 Minn. L. Rev. 106. The questions of policy involved are not, however, for this court. The whole course of the law from Brushaber through Sprouse compels the nature of our decision here, viz., that the stock dividends are not taxable. We conclude that Judge Van Fossan, dissenting in the Tax Court, reached the correct conclusion. See 14 T.C. at page 153. Cf. the decision of the Court of Appeals for the Seventh Circuit in the Tourtelot case.

The decisions of the Tax Court will be reversed.