The questions for decision concern the taxation as income of a dividend in preferred stock and the proceeds received on its sale.
On June 29, 1929, the Hamilton Manufacturing Company, a Wisconsin corporation, had outstanding preferred stock of the par value of $100 a share and common stock without par value. On that day the directors declared from the surplus earnings a dividend of $14 a share on the common stock, payable on July 1, 1929, in preferred stock at its par value. Gowran, as owner of common stock, received as his dividend 533 and a fraction shares of the preferred. On or about October 1, 1929, the company acquired his preferred stock and paid him therefor, at $100 a share, $53,371.50. In his income tax return for the year Gowran did not treat this sum as taxable income, but included $27,262.72 as capital net gain on the shares received and sold, computing the gain under articles 58 and 600 of regulations 74, then in force. The Commissioner rejected that treatment of the matter; determined that the $53,371.50 received was income taxable under the Revenue Act of 1928, § 115(g), 45 Stat. 791, 822 (26 U.S.C.A. § 115(g) and note), as a stock dividend redeemed; and assessed a deficiency of $5,831.67.
The taxpayer sought a redetermination by the Board of Tax Appeals. A division of the Board concluded, upon testimony and stipulated facts, that there had been no cancellation or redemption of the preferred stock so as to make it a taxable dividend under section 115(g); that the transaction by which the company acquired it constituted a sale. The Commissioner secured a reconsideration of the case. He then contended that, under the rule declared in Commissioner of Internal Revenue v. Tillotson Mfg. Co. (C.C.A.) 76 F.2d 189, the stock dividend was taxable, because it had resulted in a change of Gowran's proportionate interest in the company. That contention was sustained by the Board; and, on that ground, it affirmed the Commissioner's determination of a deficiency. Gowran v. Com'r, 32 B.T.A. 820.
The taxpayer sought a review by the Circuit Court of Appeals. The Commissioner again urged that the stock dividend was taxable; and then, for the first time, contended that, even if it was not taxable, the determination of the deficiency should be affirmed, because within the tax year the stock had been sold at its par value and, as its cost had been zero, the entire proceeds constituted income. The Court of Appeals recognized that, since the dividends in preferred stock gave to Gowran an interest different in character from that which his common stock represented, it was constitutionally taxable under Koshland v. Helvering, 298 U.S. 441, 56 S.Ct. 767, 80 L.Ed. 1268, 105 A.L.R. 756; but it held that the dividend could not be taxed as income, since by section 115(f), 26 U.S.C.A. § 115(f) and note, Congress had provided: 'A stock dividend shall not be subject to tax.' And it held further that no part of the proceeds could be taxed as income, since there was no profit on the sale, it being agreed that the fair market value of the stock, both at the date of receipt and at the date of the sale, was $100 a share. Gowran v. Com'r, 87 F.2d 125.
Because of the importance of the questions presented in the administration of the revenue laws, certiorari was granted. 301 U.S. 676, 57 S.Ct. 924, 81 L.Ed. 1337.
First. The government contends that section 115(f) should be read as prohibiting taxation only of those stock dividends which the Constitution does not permit to be taxed; and that, since by the dividend Gowran acquired an interest in the corporation essentially different from that theretofore represented by his common stock, the dividend was taxable. In support of that construction of section 115(f), it is urged that Congress has in income tax legislation manifested generally its intention to use, to the full extent, its constitutional power, Helvering v. Stockholms Enskilda Bank, 293 U.S. 84, 89, 55 S.Ct. 50, 52, 79 L.Ed. 211; Douglas v. Willcuts, 296 U.S. 1, 9, 56 S.Ct. 59, 80 L.Ed. 3, 101 A.L.R. 391; that this Court holds grants of immunity from taxation should always be strictly construed, Pacific Co. v. Johnson, 285 U.S. 480, 491, 52 S.Ct. 424, 426, 76 L.Ed. 893; and that the only reason for exempting stock dividends was to comply with the Constitution.