These cases present the question of the construction of the following provisions of section 201 of the Revenue Act of 1921, 42 Stat. 228:
'Sec. 201. (a) That the term 'dividend' when used in this title * * * means any distribution made by a corporation to its shareholders or members, whether in cash or in other property, out of its earnings or profits accumulated since February 28, 1913. * *
'(b) For the purposes of this Act every distribution is made out of earnings or profits, and from the most recently accumulated earnings or profits, to the extent of such earnings or profits accumulated since February 28, 1913; but any earnings or profits accumulated or increase in value of property accrued prior to March 1, 1913, may be distributed exempt from the tax, after the earnings and profits accumulated since February 28, 1913, have been distributed. * * *'
The respondent in No. 158 and the petitioner in No. 212 are stockholders of the West Side Lumber Company, a California corporation. The question is as to the amount properly taxable against them as their respective shares of a dividend of $5,100,000 paid by that company on April 14, 1923.
The findings of fact state that, in addition to its original capital of $1,500,000, the company had a surplus on March 1, 1913, of $4,332,684.78. Its profits and losses in the following years ending on February 28 in each year-were as follows: 1914, a profit of $4,594.62; 1915, a loss of $193,139.67; 1916, a loss of $211,707.32; 1917 to 1923, inclusive, and from February 28, 1923, to April 14, 1923, profits aggregating $2,450,688.30. Prior to the dividend here involved, and for the years 1918 to 1923, the company had paid dividends amounting to $1,290,000.
The question is as to the proper treatment of the lesses of 1915 and 1916. If these losses, over the profits of 1914, are not treated as reducing the surplus of March 1, 1913, but are charged against the subsequent profits, the entire amount of that surplus, or $4,332,684.78, was distributable exempt from the tax after the profits subsequent to February 28, 1913, had been distributed. On this basis, for which the taxpayers contend, the profits accumulated after February 28, 1913, would be deemed to amount to $2,050,435.93, leaving subject to the tax, after deducting prior dividends, the sum of $760,435.93.
If the losses of 1915 and 1916, over the profits of 1914, are treated as reducing the surplus of March 1, 1913, there remained of that surplus, on February 28, 1916, the sum of $3,932,432.41, which was distributable exempt from the tax after the subsequent profits had been distributed. With this application of the losses of 1915 and 1916, the subsequent profits subject to tax, after deducting prior dividends, amounted to $1,160,688.30.
The Board of Tax Appeals adopted the latter view and directed the determination of deficiencies accordingly. 24 B.T.A. 480. That decision was overruled by the Circuit Court of Appeals for the Seventh Circuit as to the respondent Canfield in No. 158 (62 F.(2d) 751), and was sustained by the Circuit Court of Appeals for the Ninth Circuit as to the petitioner Thorsen in No. 212 (65 F.(2d) 234). The cases come here on certiorari.
In deciding between these conflicting views, the outstanding, and we think the controlling, fact is that on February 28, 1916, the surplus of March 1, 1913, had actually been diminished by losses. The company continued in business after March 1, 1913, and exposed its accumulated profits to the hazard of that business. On February 28, 1914, the company still had those profits and an additional profit of $4,594.62. But in the next two years the company lost $404,846.99, so that the surplus of March 1, 1913, was invaded. It is inaccurate to say that this was merely a matter of bookkeeping. Under the findings of fact, the losses must be deemed to have been actual losses, not mere bookkeeping entries. Hence the decrease of the pre-existing surplus was actual-as real as the pre-existing surplus itself, as real as the subsequent profits. The surplus of March 1, 1913, was the amount of net assets over liabilities including capital stock. When the losses of 1915 and 1916 were suffered, the net assets of March 1, 1913, shrunk accordingly.