General Utilities & Operating Co. v. Helvering Supreme Court of the United States, U.S. 200, 56 S.Ct. 185 Todd Harris June 20, 2007 Tax 8020

Background Jan. 1927, General Utilities purchases 20,000 shares of Island Edison for $2,000 Jan. 1927, General Utilities purchases 20,000 shares of Island Edison for $2,000 Jan. 1928, Southern Cities Utilities wants to purchase all shares of Island Edison Jan. 1928, Southern Cities Utilities wants to purchase all shares of Island Edison Direct sale of shares to Southern Cities would impose double taxation on General Utilities Direct sale of shares to Southern Cities would impose double taxation on General Utilities Mar. 1928, General Utilities declares dividend Mar. 1928, General Utilities declares dividend Dividend consists of shares of Island Edison and they value these shares at $56 ½ Dividend consists of shares of Island Edison and they value these shares at $56 ½

Background Cont’d 19,090 shares of Island Edison distributed among all 33 shareholders 19,090 shares of Island Edison distributed among all 33 shareholders General Utilities retains 910 shares General Utilities retains 910 shares All shareholders sell to Southern Cities at $56 ½ All shareholders sell to Southern Cities at $56 ½ General Utilities only pays tax on sale of 910 shares General Utilities only pays tax on sale of 910 shares Commissioner declares additional taxable gain upon 19,090 shares of stock used in payment of dividend Commissioner declares additional taxable gain upon 19,090 shares of stock used in payment of dividend

General Utilities Argument General Utilities indebted to shareholders upon dividend – property (stock) delivered to shareholders less than debt constitutes income General Utilities indebted to shareholders upon dividend – property (stock) delivered to shareholders less than debt constitutes income Commissioner’s Argument No capital gain from appreciation and No capital gain from appreciation and subsequent distribution of shares subsequent distribution of shares

Ruling Board of Tax Appeals declared no taxable gain realized by General Utilities, not subject to additional tax Board of Tax Appeals declared no taxable gain realized by General Utilities, not subject to additional tax 4 th Circuit Court of Appeals reversed decision 4 th Circuit Court of Appeals reversed decision Disagreed with Commissioner and found that there was no taxable gain from dividend Disagreed with Commissioner and found that there was no taxable gain from dividend Even though not argued by Commissioner, Appeals Court ruled on whether sale of stock was really by General Utilities and that they merely used their shareholders as agents for the sale Even though not argued by Commissioner, Appeals Court ruled on whether sale of stock was really by General Utilities and that they merely used their shareholders as agents for the sale Found that shareholders were merely conduits through which General Utilities transferred title and avoided taxation Found that shareholders were merely conduits through which General Utilities transferred title and avoided taxation Cited with Commissioner – Reversed Board’s ruling Cited with Commissioner – Reversed Board’s ruling

Ruling Cont’d Supreme Court reversed Appeals Court, cited with Board and General Utilities Supreme Court reversed Appeals Court, cited with Board and General Utilities Agreed with both courts, no taxable gain from dividend Agreed with both courts, no taxable gain from dividend Found that Appeals Court can only rule on law and cannot infer facts not stipulated Found that Appeals Court can only rule on law and cannot infer facts not stipulated

Conclusion General Utilities allowed corporations to give appreciated property to shareholders without declaring a taxable gain General Utilities allowed corporations to give appreciated property to shareholders without declaring a taxable gain Only operating income would be subject to double taxation Only operating income would be subject to double taxation Tax Reform Act of 1986 repealed General Utilities – appreciated property now subject to double taxation Tax Reform Act of 1986 repealed General Utilities – appreciated property now subject to double taxation