Stock dividends;

              46 HASKINS & SELLS April
Stock Dividends
Stock dividends have perhaps received
as much attention and discussion as any
other topic connected with revenue legisla­tion
and administration. The recent de­cision
of the United States Supreme Court
appears not to have settled all the questions
relating to stock dividends. Already there
is evidence of attempts to offset the advan­tages
accruing to taxpayers under the de­cision.
The following letter addressed recently
to one of our clients sets forth the present
status of the stock dividend situation and
contains some conservative advice on the
subject:
Dear Sirs:
Replying to your request of the 15th in­stant
for our views on the following ques­tion:
"On March 1, 1913, our surplus was ap­proximately
$1,300,000. On June 30,
1920, it is estimated that this surplus
will be approximately $6,000,000. Can
we, on that date, declare a stock dividend
of $5,000,000 and a cash dividend of
$1,000,000? When paying stock divi­dends
does the Government consider
that this covers the most recent earnings
in the same manner as cash dividends
would be held?"
Under the Revenue Act of 1918, a divi­dend
was defined as "any distribution made
by a corporation to its stockholders or
members whether in cash or in other prop­erty,
or in stock of the corporation out of
its earnings or profits accumulated since
February 28, 1913." It was provided that
"any distribution made in the year 1918
or any year thereafter shall be deemed to
have been made from earnings or profits
accumulated since February 28, 1913, but
any earnings or profits accumulated prior
to March 1, 1913, may be distributed in
stock dividends or otherwise, exempt from
the tax, after the earnings and profits ac­cumulated
since February 28, 1913, have
been distributed."
Under these provisions a dividend,
either stock or cash, might be declared to
exhaust the profits accumulated since Feb­ruary
28, 1913, and that thereafter tax
free distributions might be made from
earnings accumulated prior to March 1,
1913.
The Supreme Court having declared
stock dividends not taxable, it would ap­pear
to follow that a corporation might
declare a stock dividend to exhaust the
earnings accumulated subsequent to Feb­ruary
28, 1913, and then declare a cash
dividend from earnings prior to March
1, 1913, which cash dividend would not be
taxable to the recipients.
Two broad questions arise in this con­nection—(
1) whether under the existing
law, as interpreted by the Supreme Court,
such a tax exempt cash dividend could be
declared; and (2) whether Congress will
amend the law so as to tax such dividend
or provide a special tax for the privilege
of declaring a stock dividend.
Under the first broad question there are
two subsidiary questions to be considered:
(1) Is a stock dividend a distribution of
profits? (2) Is a dividend necessarily
deemed to be out of the most recently ac­cumulated
surplus?
In the discussion of the first subsidiary
question, it should be noted that section
201 (b) provides that earnings or profits
accumulated prior to March 1, 1913, may
be distributed exempt from tax after the
earnings or profits accumulated since Feb­ruary
28, 1913, have been distributed. It
is chiefly under this provision that a divi­dend
declared out of earnings accumulated
before the incidence of the Income Tax
Law would be tax exempt. Under the
Revenue Act as it was passed, a stock divi­dend
was a distribution of earnings and
profits. It would appear, however, that