By an indenture denominated a 'lease' respondent in 1864 granted, demised and leased to Chicago & Alton Railroad Co. all of its railroad property, real and personal. The 'lease' was in perpetuity upon specified terms and conditions. The Chicago & Alton Railroad Co. covenanted and agreed, inter alia, to guarantee and pay quarterly to the holders of the fifteen thousand shares of capital stock of respondent an annual dividend of seven per cent on the par value of the shares; to deposit with a designated depository specified monthly sums to be placed to the credit of the stockholders and to be held as a fund for the purpose of paying the dividends; to pay the dividends without any deduction for any federal tax whatsoever; to pay all taxes which may be due to the United States 'on account of said dividend so paid from time to time'; and to pledge to respondent thirty-seven parts out of two hundred and fifty-seven parts of the gross receipts of the line between the cities of Alton and Chicago for the purpose of securing the performance of its various covenants. The 'lease' contained no defeasance clause.
The annual dividend is.$7.00 per share and totals $105,000.00. This amount has been paid directly to respondent's stockholders every year since 1864-by Chicago & Alton Railroad Co. until acquisition of the property in 1931 by the Alton Railroad Co., and since then by the latter company. The dispute here is over federal income taxes for the years 1931, 1932, 1933 and 1934. Respondent, a corporation organized and existing under the laws of Illinois, filed its income tax return for each of those years reporting the $105,000.00 of dividends paid its shareholders as its income. The resulting tax was paid each year by the Alton Railroad Co. In addition the latter paid each year for respondent an additional tax on the amount of the income tax on $105,000.00 on the theory that the latter constituted additional taxable income to respondent. Respondent filed claims for refund for the additional tax paid in 1931 and for all the income taxes paid on its behalf for the other years in question on the theory that the income on which those taxes were paid was not realized by it. On rejection of those claims by the Commissioner respondent instituted suit in the District Court. That court rendered judgment for the petitioner. The Circuit Court of Appeals reversed, one judge dissenting. 118 F.2d 174. We granted the petiton for certiorari, 314 U.S. 591, 62 S.Ct. 70, 86 L.Ed. --, because of the conflict between that decision and the governing principles of Gold & Stock Telegraph Co. v. Commissioner, 83 F.2d 465, United States v. Northwestern Telegraph Co., 83 F.2d 468, and Pacific & Atlantic Telegraph Co. v. Commissioner, 83 F.2d 469, decided by the Circuit Court of Appeals for the Second Circuit.
Respondent urges, and the court below held, that this so-called lease in perpetuity without a defeasance clause divested respondent of all right, title and interest in the property and vested a full and indefeasible title in the grantee. See Huck v. Chicago & Alton Railroad Co., 86 Ill. 352, 354, 355; Chicago, Burlington & Quincy R.R. Co. v. Boyd, 118 Ill. 73, 7 N.E. 487. Respondent also argues that the indenture of 1864 vested all rights to payment of dividends in its stockholders and divested it of any right to, or control over, such payments. Respondent therefore contends that a corporation which does not own or control property and has no right to, or control over, any income from the property cannot be in receipt of income, constructively or otherwise.
Such considerations do not dispose of this controversy. In Lucas v. Earl, 281 U.S. 111, 50 S.Ct. 241, 74 L.Ed. 731, this Court held that a husband's salary was taxable to him though by contract with his wife half of it vested in her when paid. Mr. Justice Holmes said (281 U.S. at pages 114, 115, 50 S.Ct. at page 241, 74 L.Ed. 731): 'There is no doubt that the statute could tax salaries to those who earned them and provide that the tax could not be escaped by anticipatory arrangements and contracts however skilfully devised to prevent the salary when paid from vesting even for a second in the man who earned it. That seems to us the import of the statute before us and we think that no distinction can be taken according to the motives leading to the arrangement by which the fruits are attributed to a different tree from that on which they grew.'
Precisely that approach was taken in Art. 70 of Treasury Regulations 74, promulgated under the Revenue Act of 1928. It provides in part: