In this case the Circuit Court of Appeals held the respondent entitled to include in its dividends paid credit, pursuant to Section 27 of the Revenue Act of 1938, the amount paid to redeem notes given for dividends in a prior year. The Circuit Court of Appeals of the Ninth Circuit had held to the contrary. To resolve the conflict we granted certiorari. 317 U.S. 620, 63 S.Ct. 266, 87 L.Ed. --.
In 1937 the respondent paid dividends, $30,000 in cash and $530,000 in its ten year eight per cent notes. As respects its liability for undistributed profits tax, it claimed and was allowed, pursuant to § 27(d) of the Revenue Act of 1936, as part of its 'dividends paid credit', the face value of the notes. In 1938 the respondent paid off the notes, and in its return for that year claimed the sum paid as a part of its 'dividends paid credit' under the Revenue Act of 1938, § 27(a)(4). The Commissioner's disallowance of the claim was sustained by the Board of Tax Appeals, but the Circuit Court of Appeals reversed the Board's decision.
The position of the petitioner is that the second credit claimed would duplicate the earlier one allowed and that § 27 of the Revenue Act of 1938 does not permit the duplication.
The Revenue Act of 1936, by § 13, 26 U.S.C.A. Int.Rev.Acts, page 822, imposed on corporations a tax ranging from eight to fifteen per cent of the so-called 'normal-tax net income', consisting of net income less certain permitted deductions. It then laid a graduated surtax on 'undistributed net income' which it defined as the adjusted net income (the normal-tax net income after credits) less the so-called 'dividends paid credit', section 14, 26 U.S.C.A. Int.Rev.Acts, page 823. By § 27 the Act defined the latter as comprising dividends paid during the taxable year including (27(d)) dividends in obligations of the company to be reckoned at face value or market value, whichever was lower. The subsection also provided that, if such obligations were redeemed in any subsequent year, the excess of the redemption payment over the fair market value of the obligations as of the date of their issue should be treated as a dividend paid in the year of redemption.
The purpose of these provisions is clear and is a matter of common knowledge. Congress desired to encourage the payment of dividends so that the earnings of corporations might be subjected not only to normal tax as against the corporation, but also to taxation as income to the stockholders. The means adopted was to relieve the corporation from surtax to the extent of dividends paid in cash or in obligations. The latter would be taxed to stockholders at their market value. If they were redeemed in a later year, at a figure above such value as of the date of their issue, the excess would be taxed to the holder as income to him in the year of redemption. Fairness dictated that in such case the corporation should have a further dividends paid credit for this excess of value paid by it.
The Revenue Act of 1938 adopted a different plan of corporate taxation. With respect to a corporation having the amount of income earned by the respondent, § 13 imposed a tentative tax of 19% of 'adjusted net income', which was the entire net income less certain deductions not here material. This tentative tax was to be reduced by the sum of two deductions. One of these is not in issue here. The other is 2 1/2% of the 'dividends paid credit', not however to exceed 2 1/2% of the adjusted net income. The dividends paid credit is defined by § 27. It consists of four items, two of which are carry-overs from previous years, which need not concern us; and two others which are important in this case,-first, the 'basic surtax credit', § (a)(1), and, secondly, 'amounts used * * * to pay or to retire indebtedness of any kind, if such amounts are reasonable with respect to the size and terms of such indebtedness,' (a)(4). Indebtedness is defined as indebtedness existing at the close of business December 31, 1937, and evidenced by bond, note, debenture, certificate of indebtedness, mortgage or deed of trust issued by the corporation and in existence at the close of business December 31, 1937, or a bill of exchange accepted prior to and in existence at that time. The term is further defined as covering principal only and not interest thereon.