Income tax pitfall;

              Bulletin HASKINS & SELLS 71
A RECENT decision of the United States
Supreme Court, rendered in the case
of Marr vs. United States (45 Sup. Ct.
Rep. 575), has an important bearing on
the income tax liability of stockholders in
corporate reorganizations.
Under the law, the fact that shares of
corporate stock increase in value does not
subject the holder thereof to a tax on the
increase as income. The tax is imposed
upon income, and not upon capital invested
or property as such.
Further, a bona fide stock dividend is
not taxable, according to the decision of
the United States Supreme Court in the
famous case of Eisner vs. Macomber.
The rule is that "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."
The question raised in the present case
was whether or not, in a corporate reor­ganization,
an income tax can be levied
on the excess of the value of the stock
issued by the new company, over the cost
of the stock in the old company.
The effect of the decision which was
rendered is that the procedure followed in
the reorganization is the deciding factor in
determining the propriety of a tax. In
general, if the identity of the business
enterprise is maintained and there is no
change in the proportional interests of
the stockholders in the company, then no
tax on income can be imposed. But if
these identities are not preserved, the im­position
of a tax is proper.
The facts in the case were as follows:
Prior to 1913, Marr purchased 339
shares of preferred and 425 shares of
common stock of the General Motors
Company, a New Jersey corporation, for
$76,400.00. He held the shares for a
number of years.
In 1916 this corporation had outstand­ing
$15,000,000 of 7% preferred stock and
$15,000,000 of common stock, all of the
par value of $100 per share. It had accu­mulated
a large surplus, so that the value
of its common stock was $842.50 per share.
There was then organized the General
Motors Corporation, a Delaware corpora­tion,
with an authorized capital of $20,000,-
000 of 6% non-voting preferred stock
and $82,600,000 of common stock, all of
the par value of $100 per share. The
Delaware corporation issued its stock in
exchange for that of the New Jersey
corporation, on the following basis: one
and one-third shares of new preferred
stock for each share of old, and five shares
of new common stock for each share of
old, with cash payments for fractional
shares. The Delaware corporation thus
became the owner of all the outstanding
stock of the New Jersey corporation, and
took over its assets and assumed its lia­bilities.
The latter was then dissolved.
There remained $7,600,000 of authorized
common stock in the new company, which
was not required for the exchange. This
was either sold or retained for sale in the
future.
Marr received in exchange for his hold­ings
451 shares of preferred and 2,125
shares of common stock in the Delaware
corporation, which, including a small
cash payment, had an aggregate market
value of $400,866.57. This was $324,-
466.57 greater than the original cost of his
stock in the New Jersey corporation. The
Treasury Department assessed a tax on
this amount, pursuant to the Revenue
Act of 1916. Marr paid the tax under
protest, and litigation resulted.
An Income Tax Pitfall