*1396 1. Petitioner, a nonresident alien, during years 1925 to 1935, inclusive, received certain payments from a foreign corporation in which he owned all the capital stock except qualifying shares. More than 50 percent of the gross income of such foreign corporation for the periods here in question was derived from sources within the United States. Held, to the extent the amounts received constituted dividends, petitioner is taxable thereon under the provisions of section 217(a)(2)(B) of the Revenue Act of 1926 and section 119(a)(2)(B) of the Revenue Acts of 1928, 1932, and 1934, respectively. Lord Forres,25 B.T.A. 154">25 B.T.A. 154, followed; held, further, the amounts received by petitioner constituted dividends only to the extent of $19,996 (Canadian money) in 1926 and $165,883.46 (Canadian money) in 1935, and that all other payments were in discharge of legal and binding obligations of the corporation to petitioner.
2. Where petitioner failed to file any return for 1926, held, the addition of the 25 percent delinquency penalty is mandatory.
3. Where petitioner failed to file a return for 1935 until after the respondent had made his determination for that*1397 year and petitioner had filed a petition before the Board, and the Commissioner had filed his answer thereto and issue had been joined between the parties, held the impoaition of the 25 percent delinquency penalty for that year was proper.
4. Where petitioner failed to file any return for 1926, held, in computing petitioner's normal tax liability for 1926, section 217(g)(1) of the Revenue Act of 1926 precludes any allowance of a credit for dividends from a foreign corporation otherwise allowable under section 216(a)(2) of the same act.
5. Where the Revenue Act of 1934 allows no credit for dividends from foreign corporations, held, the respondent erred in allowing petitioner such a credit for the year 1935.
6. Where petitioner received certain dividends in Canadian dollars which were returnable for purposes of United States taxation, held, such dividends should be expressed in terms of United States money at the rate of exchange in force at the time of their receipt.
*1398 *2 This proceeding involves deficiencies in income tax and 25 percent penalties determined against petitioner for years and in amounts as follows:
| Year | Deficiency | 25% penalty |
| 1925 | $62,209.24 | $15,552.31 |
| 1926 | 31,494.70 | 7,873.68 |
| 1927 | 31,660.00 | 7,915.00 |
| 1928 | 113.00 | 28.25 |
| 1929 | 25,539.52 | 6,384.88 |
| 1930 | 2.00 | .50 |
| 1931 | $1,622.56 | $405.64 |
| 1932 | None | None |
| 1933 | 80.00 | 20.00 |
| 1934 | 40.00 | 10.00 |
| 1935 | 234,779.96 | 58,694.99 |
The deficiencies arise from the respondent's determination that certain payments received by petitioner, a nonresident alien, from the Ross Corporation, Ltd., a foreign corporation, during the period 1925 to 1935, inclusive, represented "dividends" subject to tax under section 217(a)(2)(B) of the Revenue Act of 1926 and section 119(a)(2)(B) of the Revenue Acts of 1928, 1932, and 1934, respectively. Petitioner contests the legality of the respondent's entire determination. On the other hand, the respondent, in his third amended answer to the petition as amended, affirmatively alleges that the correct amount of dividends received by petitioner in the year 1926 was $228,391.20 instead of the amount of $199,173.52 determined*1399 in the deficiency notice; that the respondent had erroneously allowed as credits against net income for normal tax purposes the amount received as dividends in each of the years involved; and that because of these errors there were due from petitioner additional deficiencies and penalties for each of the years involved over and above those determined by the respondent in his deficiency notice. The respondent in due manner has made claim for the alleged additional deficiencies and penalties.
The primary issue is whether the Government of the United States has the sovereign power to impose a tax upon the person or the income of a citizen and resident of the Dominion of Canada who has never resided, carried on business, or maintained an office in the United States and has not, during any of the years involved, owned any kind of property whatsoever situated in the United States; and whether the imposition of such a tax would constitute a denial of due process of law in contravention of the Fifth Amendment to the Constitution of the United States. If this primary issue be decided against petitioner, then the additional issues to be considered are as follows:
*3 1. To what*1400 extent, if any, did the payments which were received by petitioner from the Ross Corporation, Ltd., constitute repayments of indebtedness as distinguished from the receipt of dividends?
2. To what extent, if any, should the 25 percent penalties be imposed?
3. Is petitioner entitled to a credit for dividends received in computing his income subject to normal tax?
4. Should the payments received in Canadian dollars by petitioner from the Ross Corporation, Ltd., be converted into United States currency at the rates of exchange existing on the dates of payment or at the end of the year?
FINDINGS OF FACT.
Petitioner is, and at all times material to this proceeding has been, a citizen of the Dominion of Canada, and a resident of the Province of Quebec, Canada. He has never resided in nor carried on business in the United States.
Petitioner has never at any time owned any real or personal property situated in the United States except, prior to 1922, certain stocks and bonds issued by corporations organized under the laws of the United States or one of the states or territories thereof, nor has he had any bank balances in the United States, and since 1922 has never owned*1401 any securities issued by corporations organized under the laws of the United States or one of the states or territories thereof. Certificates of stocks and bonds owned by him have always been kept in the city of Quebec and at no other place.
The Ross Corporation, Ltd. (hereinafter sometimes referred to as the Ross Corporation), was incorporated on March 4, 1922, under chapter 79 of the Revised Statutes of Canada, 1906, known as "The Companies Act", and acts amendatory thereto, by the issuance of its charter, termed Letters Patent, dated March 4, 1922. The charter authorizes the corporation in broad terms to engage in a wide variety of business, including the buying and selling of property of every nature. However, substantially all of the business of Ross Corporation has been the collection of interest and dividends on securities transferred to it by petitioner as hereinafter set forth. The sources of its annual income for the years 1922 to 1935, inclusive, are disclosed by Exhibit K, which is hereby made a part of these findings and is incorporated herein by reference. All the capital stock of the Ross Corporation has been owned by petitioner at all times material to this*1402 proceeding, with the exception of four qualifying shares. By its charter and its bylaws the corporation was prohibited from inviting the public to subscribe for any of its shares or debentures.
*4 In 1922, at the time of the incorporation of the Ross Corporation, petitioner owned various securities, consisting of stocks and bonds of corporations incorporated in and having their head offices in Quebec, stocks and bonds of corporations incorporated in and having their head offices elsewhere in Canada, bearer bonds of the Dominion of Canada, stocks and bonds of corporations organized under the laws of the United States or one of the states or territories thereof, and some stocks and bonds issued by corporations of other countries.
In accordance with an agreement entered into on April 27, 1922, between petitioner and the Ross Corporation, petitioner transferred and conveyed to that corporation certain of his stocks and bonds at values ascertained by certain of his employees at their then current selling prices. The securities so valued and transferred consisted of the following:
| Bonds of the United States and stocks and bonds of corporations organized under the laws of the United States or of a state or territory thereof | $2,247,879 |
| Canadian securities | 712,600 |
| 2,960,479 |
*1403 The aforementioned agreement was approved by the board of directors of the Ross Corporation at a meeting held on April 27, 1922, subject to the approval of the shareholders and was submitted to and approved by the shareholders at a meeting held later on that day, the president and secretary being authorized to execute the agreement. Petitioner transferred to the Ross Corporation the securities listed in the schedule attached to the proposal and in addition paid to the Ross Corporation the sum of $21. The corporation in consideration of the transfer issued to petitioner and the qualifying shareholders 20,000 shares of its capital stock of a par value of $100 per share, or $2,000,000 par value, that being all of the issued stock, and its duly executed promissory note payable to petitioner on demand for $960,500, with interest at 6 percent per annum.
After the transfer of the aforementioned United States stocks and bonds to the Ross Corporation, petitioner did not own, and has not since owned, any securities issued by a corporation organized under the laws of the United States or a state or territory thereof.
On December 18, 1922, the directors of the Ross Corporation passed*1404 a resolution, the material part of which is as follows:
That this Company purchase from Frank W. Ross the following Stocks and Bonds, at prices set opposite each, and that same be settled for by Company's Demand Note, without Interest.
* * *
| Stocks | $269,400.00 |
| Bonds | 117,000.00 |
| $386,400.00 |
*5 Said Stocks and Bonds to be transferred, as on 1st. January, 1923, and the President and Secretary, be and are hereby authorized to execute a Promissory Note, payable on demand, without interest, to the order of FRANK W. Ross, for the sum of $386,400.00 constituting amount of the purchase price of above Stocks and Bonds.
None of the securities mentioned in the above resolution were issued by a corporation organized under the laws of the United States or of a state or territory thereof. These securities were transferred and conveyed to the Ross Corporation by petitioner, but the note referred to in the resolution was not executed. The amount of $386,400 stated in the resolution as the sale price was, on January 1, 1923, through a bookkeeping error, credited to capital account. This error was corrected a year later on January 1, 1924, and this amount debited*1405 to capital and credited to an account payable designated as "F. W. Ross."
The various securities involved in the transactions of April 27 and December 28, 1922, were actually transferred and conveyed by petitioner to the Ross Corporation. The 20,000 shares of capital stock of the corporation and its note for $960,500 were duly issued, executed, and delivered to petitioner. The note was kept by petitioner in his safe deposit box in his bank and destroyed at or about the end of 1929, when payments received by petitioner from the Ross Corporation aggregated $960,500.
The corporation reflected its obligation of $960,500 on its ledger by opening a bills payable account in that amount, and after January 1, 1924, the obligation of $386,400 was reflected in the "F. W. Ross" account payable. Entries regarding the acquisition of all securities, the receipt of the $21 cash, the issuance of capital stock, the issuance of the note, the opening of the ledger bills payable account, and the opening of the ledger account payable to F. W. Ross were all entered in the journal of the Ross Corporation.
On December 23, 1925, petitioner informed a meeting of the shareholders of the Ross Corporation*1406 that, in view of heavy losses by the corporation on some stock sold and depreciation in the value of others, he was canceling his claim for accrued interest on the company's demand note, as well as interest to accrue. This cancellation and waiver of interest was effective and valid under the law of Canada.
The Ross Corporation, since its organization, has had its own place of business in the city of Quebec, Province of Quebec, Dominion of Canada, and at no other place. That place of business was in the office of petitioner and its only employees were also employees of petitioner. Since its organization in 1922, the corporation has not had an office in the United States and has carried on its business exclusively in the city of Quebec. The certificates of stocks and bonds *6 owned by it have always been kept in its safe deposit box in its bank in Quebec and at no other place. These certificates have always been registered in its own name and dividends and interest received on stocks and bonds owned by it have been deposited to its account in the Royal Bank of Canada, in Quebec, which bank account has always been in Canadian dollars.
The Ross Corporation has never owned*1407 any property situated in the United States whatsoever except certain stocks and bonds issued by corporations organized under the laws of the United States or a state or territory thereof. The certificates of such stocks and bonds were never kept in the United States and income derived therefrom was never deposited in the United States. Whenever it purchased or sold securities, including United States securities, it made such purchases and sales through the Montreal Trust Co. at Quebec or through Canadian brokers. Pursuant to the action of the board of directors of the Ross Corporation on August 12, 1936, the corporation delivered all its securities of United States corporations, with the exception of two worthless items, to the Montreal Trust Co., with instructions that they be sold. All United States securities owned by the corporation, with the exception of a few worthless and unmarketable items, were in fact sold, such sales taking place for the most part in 1936 and, to some extent, the early part of 1937. Since the sale of its United States securities the Ross Corporation has not owned any United States securities of any value whatsoever.
The first officers of the Ross*1408 Corporation were elected from the incorporators, who were members of the staff of Brown, Montgomery & McMichael, Montreal attorneys, and were originally the holders of the qualifying shares. On April 27, 1922, the resignations of the then existing officers were filed and accepted and the following officers were elected: Frank W. Ross, president; G. R. Moir, treasurer; and Robert Hunter, secretary. Moir and Hunter were elected directors at a shareholders' meeting on May 1, 1922, at which time the shareholders consisted of the petitioner, Moir, Hunter, Alice E. Ross, and A. B. Burstall. On May 1, 1922, Moir was elected vice president in addition to treasurer. On March 19, 1927, Alice E. Ross was made a director and also vice president, succeeding Moir, who had recently died. Hunter was elected treasurer in addition to secretary and on November 24, 1927, resigned as secretary, when K. O. Baptist was elected. On February 16, 1928, Hunter became vice president in addition to treasurer.
Alice E. Ross is the wife of petitioner, and the other shareholders, directors, and officers named above were employees of petitioner, as well as of the corporation.
*7 The salaries of*1409 officers of the Ross Corporation aggregated $2,000 annually, of which $1,000 was paid to the president and $500 each to the secretary and treasurer. No modification of this arrangement was made except for the year 1927, when Hunter received $1,000. Hunter, Baptist, and Moir also received compensation from the petitioner for other services to him in connection with his individual affairs.
The reasons for the organization of the Ross Corporation were twofold. The primary purpose was to avoid the imposition of multiple succession duties upon the assets of petitioner's estate at the time of his death. The entire assets of the estate of a man dying in the Province of Quebec would be subject to Quebec succession duties, and in the case of securities, would be subject to succession duties, inheritance taxes, or estate taxes in other provinces or in states of the United States if the issuing corporations were incorporated or had their head offices there, with the result that frequently double and sometimes triple death taxes were imposed. The idea in incorporating personal holding companies was to vest all the non-Quebec assets in a company having its head office in Quebec so that*1410 the entire estate would be localized in Quebec and Quebec only at the time of death. The other reason for the incorporation of the Ross Corporation was the provision of chapter 29, section 14, subsection 7-A of the Revised Statutes of Quebec to the effect that no legacy can be paid, no share transferred, and nothing whatever done with the assets of an estate until succession duties are first paid in full, which in the case of a large estate often means months and years, during which time the whole estate is "locked up." There is no provision under Canadian law for the giving of a bond or other security for the payment of succession duties. Under these provisions of the Quebec succession duty law, the shares of a corporation owned by the decedent at the time of death may not be sold or transferred, but the corporation itself is free to deal with its assets as it pleases and such assets are freed from the restrictions of the statute. The purpose intended to be accomplished by sale of certain securities to the corporation in addition to the transfer of others for the issuance of its stock was to introduce an element of flexibility in the investment.
Under Canadian law the shareholder*1411 of a Canadian corporation has no title, either legal or equitable, to or in the assets of the corporation, and this is so in a one-man company as much as it is in a company with a multitude of shareholders. At the time the Ross Corporation was organized, personal holding companies were subject to Canadian income tax under the Canadian law in the same manner as other companies, but effective in 1925 the Canadian income tax law was amended to provide that the income of personal corporations shall be deemed to be distributed at the end of the year for Canadian income tax purposes. The corporation is not assessed for any tax, but each individual *8 shareholder must include in his return his pro rata share of the income of the corporation. The recognition of the separate indentity and entity of such a corporation is required under the law of Canada.
During the years 1922 to 1929, inclusive, the Ross Corporation paid to petitioner, in Canadian dollars, exclusive of salary and an admitted dividend during 1926 of $19,996, the following amounts:
| Item | Date paid | Amount |
| 1 | Dec. 31, 1922 | $60,000.00 |
| 2 | Mar. 2, 1925 | 250,000.00 |
| 3 | July 6, 1925 | 13,827.42 |
| 4 | July 11, 1925 | 2,128.12 |
| 5 | July 22, 1925 | 1,065.84 |
| 6 | July 24, 1925 | 15,262.55 |
| 7 | July 27, 1925 | 21,936.98 |
| 8 | Sept. 1, 1925 | 1,386.30 |
| 9 | Mar. 1, 1926 | 100,000.00 |
| 10 | June 4, 1926 | 108,395.20 |
| 11 | Dec. 1, 1927 | $200,000.00 |
| 12 | Aug. 4, 1928 | 10,000.00 |
| 13 | Aug. 28, 1928 | 6,100.00 |
| 14 | Dec. 24, 1928 | 1,000.00 |
| 15 | Mar. 14, 1929 | 1,000.00 |
| 16 | July 16, 1929 | 1,000.00 |
| 17 | Dec. 31, 1929 | 167,397.59 |
| Total | $960,500.00 |
*1412 Items 1, 9, and 11 were paid pursuant to resolutions of the board of directors; the remaining items were paid without any formal authorization. All of the items when paid were debited on the corporation's books to the bills payable account representing the note given petitioner for $960,500; and such debits were supported by entries appearing in the cash book or journal.
During the years 1930 to 1935, inclusive, the Ross Corporation, without formal authorization by its directors, paid to petitioner or to others for him account, in Canadian dollars, the following amounts:
| 1930 | $10,200.80 |
| 1931 | 38,225.58 |
| 1932 | 6,000.00 |
| 1933 | 12,000.00 |
| 1934 | $5,000.00 |
| 1935 (to Aug. 28) | 280,340.68 |
| 1935 (after Aug. 28) | 200,516.40 |
The payments listed above as made to August 28, 1935, aggregating $351,767.06 were debited to the $386,400 F. W. Ross account payable account, leaving a balance in that account of $34,632.94, and thereafter no further payments were charged to that account.
On or about August 19, 1935, the corporation called in McKenzie, a chartered accountant of Montreal, to revise its books of account and to improve its system of bookkeeping. McKenzie opened*1413 a new account entitled "Frank W. Ross" as of January 1, 1935, to which he credited the unpaid balance standing in the old F. W. Ross account on December 31, 1934, and in addition the net income of the corporation for the years 1925 to 1934, inclusive, upon which petitioner had paid Canadian income tax. The items paid to petitioner in 1935, to and including August 28, which had been posted to the old F. W. Ross account were each posted to the new Frank W. Ross account. Additional payments were made to petitioner after August 28, 1935, aggregating $200,516.40, which exceeded the balance of *9 $34,632.94 due to petitioner on open account at August 28, 1935, by the sum of $165,883.46. The entries made in the old F. W. Ross account and in the new Frank W. Ross account after August 28, 1935, were in all cases supported by entries appearing either in the cash book or in the journal.
Prior to the revision of the books of account of the Ross Corporation, the various investment accounts which had been initially charged with the cost of the securities acquired from petitioner and in the open market were credited with the income received on such securities, thereby reducing the investment*1414 balance each year. This made it difficult to prepare an income statement for the corporation and tedious to determine each year the total net income of the corporation for purposes of its Canadian income tax reports, although the books of account had been accurately maintained in all respects. McKenzie made the necessary changes by restoring the original values to the investment accounts and crediting the income to appropriate and convenient surplus and income accounts. He carried to surplus all the net income of the corporation from 1922 to 1924, inclusive, thus identifying the amount of corporate earned surplus which would be subject to Canadian income tax when and if distributed. He credited the new Frank W. Ross account with the net income of the corporation for the years 1925 to 1934, inclusive, being the amount of income on which petitioner had already paid Canadian income tax and which could therefore be distributed tax-free. While his work was done in the fall of 1935, the ledger was rewritten beginning January 1, 1935. The original books, including cash books, were not altered in any way; no change was made in the manner in which the payments to petitioner were recorded.
*1415 At a meeting of the directors on December 23, 1925, the Ross Corporation declared a dividend of $20,000. This dividend was paid and petitioner received his share thereof, amounting to $19,996, on March 1, 1926. The dividend liability and the payment thereof were appropriately reflected in the ledger and cash books accounts separate from the bills payable and the F. W. Ross accounts.
The respondent has assessed and collected Federal income taxes from the Ross Corporation. A claim of the respondent that the corporation was liable for surtaxes for 1924 to 1935, inclusive, was disposed of by a settlement between the respondent and the corporation. Income taxes had been withheld at the source from interest paid to the Ross Corporation on account of its ownership of bonds of the United States or of corporations organized under the laws of the United States or a state or territory thereof.
*10 More than 50 percent of the gross income of the Ross Corporation for the three-year period ending with the close of each of the taxable years here involved (or for such part of such period as the corporation had been in existence) preceding the declaration of the $20,000 dividend*1416 on December 23, 1925, and preceding each of the payments to petitioner was derived from sources within the United States as determined under the provisions of section 219 of the Revenue Act of 1926 and section 119 of the Revenue Acts of 1928, 1932, and 1934, respectively.
After petitioner transferred and conveyed the non Quebec securities to the Ross Corporation in April and December 1922, he still owned large amounts of bearer bonds of the Dominion of Canada and other securities issued by the Quebec corporations, and had he sold even a relatively small protion of such securities and bonds to the corporation, its income from sources outside the United States would have been much in excess of 50 percent of its total income from all sources.
Petitioner filed no United States income tax return for any of the years 1925 to 1934, inclusive.
On or about January 20, 1940, petitioner filed a Federal nonresident alien income tax return, Form 1040-B, for the calendar year 1935, with the collector of internal revenue at Baltimore, Maryland, in which he claimed that he was not subject to United States income taxes.
Prior to the receipt of the respondent's preliminary notice of deficiency*1417 in income taxes dated April 23, 1937, petitioner's counsel had no knowledge or notice of the provisions of section 119(a)(2)(B) of the Revenue Act of 1934 or of similar provisions of prior revenue acts. Montgomery, who had been petitioner's attorney for over twenty years, did not call such provisions to the attention of petitioner and petitioner knew nothing about them himself until the aforementioned letter of April 23, 1937, came to his attention. Montgomery had no actual knowledge of the provisions of the section or similar provisions of prior acts and in his experience as a practicing attorney in Canada had never heard of a case in which the respondent had attempted to collect income taxes from Canadian citizens who received dividends from Canadian corporations.
All payments received by petitioner from the Ross Corporation, including the dividend received in 1926, were received in Canadian dollars. Based on the rate of exchange at the time of receipt, the value of these amounts received by petitioner in Canadian dollars in terms of United States money was as follows:
| Received in Canadian dollars | Value in U.S. money | |
| Payments on note in 1925 | $305,607.21 | $305,260.24 |
| Dividend paid March 1, 1926 | 19,996.00 | 19,991.88 |
| Payments on note in 1926 | 208,395.20 | 208,053.52 |
| Payments on note in 1928 | 17,100.00 | 17,084.93 |
| Payments on note in 1929 | 169,397.50 | 167,540.03 |
| Payments on account in 1930 | 10,200.80 | 10,208.51 |
| Payments on account in 1931 | 38,225.58 | 38,187.10 |
| Payments on account in 1932 | 6,000.00 | 5,280.52 |
| Payments on account in 1933 | 12,000.00 | 11,588.75 |
| Payments on account in 1934 | 5,000.00 | 5,054.37 |
| Payments on account in 1935 | 314,973.62 | 314,421.94 |
| Other payments in 1935 | 165,883.46 | 163,966.57 |
*1418 *11 The respondent in his deficiency notice determined that petitioner received dividends from the Ross Corporation taxable under section 217(a)(2)(B) of the Revenue Act of 1926 and section 119(a)(2)(B) of the Revenue Acts of 1928, 1932, and 1934, respectively, in amounts as follows:
| 1925 | $352,746.22 |
| 1926 | 199,173.52 |
| 1927 | 200,000.00 |
| 1928 | 17,100.00 |
| 1929 | 169,397.59 |
| 1930 | 10,200.00 |
| 1931 | $38,225.58 |
| 1932 | 6,000.00 |
| 1933 | 12,000.00 |
| 1934 | 5,000.00 |
| 1935 | 480,857.08 |
The respondent in his deficiency notice further determined that petitioner was subject to a surtax for each of the taxable years on the allgegd dividends, plus a 25 percent penalty for failure to file returns. He did not determine any normal tax liability against petitioner for any of the years.
The Ross Corporation is an entity separate and distnct from petitioner.
All payments received by petitioner from the Ross Corporation during the years 1925 to 1935, inclusive, with the exception of the dividend of $19,911.88 (United States money) in 1926 and payments aggregating $163,966.57 (United States money) in 1935, constituted payments in discharge of legal and binding obligations of*1419 the Ross Corporation to petitioner and not dividends.
During 1926 petitioner received "dividends" as that term is used in section 217(a)(2)(B) of the Revenue Act of 1926 in the amount of $19,911.88. During 1935, petitioner received "dividends" as that term is used in section 119(a)(2)(B) of the Revenue Act of 1934 in the amount of $163,966.57.
Petitioner's failure to file the 1935 income tax return within the time provided by law was not due to reasonable cause.
*12 OPINION.
BLACK: We shall consider the issues in the order of their statement. We think the primary issue is controlled by section 217(a)(2)(B) of the Revenue Act of 1926, section 119(a)(2)(B) of the Revenue Acts of 1928, 1932, and 1934, respectively, and by our decision in Lord Forres,25 B.T.A. 154">25 B.T.A. 154. The cited statutory provisions being substantially the same, we have set out in the margin only those of the 1934 Act. 1 To the extent that petitioner has received "dividends" from the Ross Croporation there can be no question as to the intent of Congress to tax such dividends. Section 211(a) of the Revenue Act of 1934 provides that "In the case of a nonresident alien individual gross*1420 income includes only the gross income from sources within the United States." To the same effect see section 213(c), Revenue Act of 1926, and section 212(a), Revenue Acts of 1928 and 1932, respectively. See also sections 210(b) and 211(a), Revenue Act of 1926, and section 4(d), Revenue Acts of 1928, 1932, and 1934, respectively.
*1421 In Lord Forres, supra, we held that such income as is involved in the instant proceeding was not beyond the taxing power of the United States as a sovereign. The only difference, which it seems to us is at all substantial, between the facts in the Lord Forres case and the facts in the instant proceeding is that in the Lord Forres case both the nonresident alien and the foreign corporation owned property in the United States, whereas in the instant proceeding, at the time of the hearing, neither the petitioner nor the Ross Corporation owned property of any value in the United States. It is our opinion that the difference in the facts between the two cases is one that concerns the collection of the tax rather than the determination of its legality, and, as we said in Winterbottom Book Cloth Co., Ltd.,43 B.T.A. 572">43 B.T.A. 572. "The Board is not concerned with the difficulties that may beset the Commissioner in collecting a deficiency in tax after redetermination. Our primary function is to determine the correct deficiency, if any, leaving to the Commissioner the enforcement or *13 collection thereof." In view of our holding in the Lord Forres*1422 case, we think this issue must be decided against petitioner.
In Lord Forres, supra, in the concluding paragraph of our opinion, among other things, we said:
Perhaps we should concede the possibility of an opposite view with respect to dividends paid by the corporation from earnings received from properties situate without the United States whose operations have received no protection and benefit from this country. But that is a matter of proof. The record discloses that the corporation's earnings from sources within the United States were more than sufficient to provide for the dividends it paid. * * *
As will be seen later on in the course of this opinion, we are holding that petitioner is taxable on dividends received from the Ross Corporation in the amount of $19,911.88 in 1926 and on dividends received in 1935 in the amount of $163,966.57. As to all other years involved we are holding that petitioner did not receive any dividends from the Ross Corporation, and, therefore, there are no deficiencies and no penalties for those years.
Exhibit K, which is a part of the record in this case and has been incorporated by reference as a part of our findings*1423 of fact, shows that at the time the 1926 and 1935 dividends were paid the Ross Corporation's earnings from sources within the United States were far in excess of the amounts of the dividends paid. Thus the situation in that respect is the same as it was in the Lord Forres case and what we said there has equal application here.
We shall now consider to what extent petitioner received "dividends" from the Ross Corporation during the years 1925 to 1935, inclusive. The facts show and petitioner concedes that on March 1, 1926, he received from the Ross Corporation a dividend in Canadian dollars amounting to $19,996. In addition to this admitted dividend petitioner during the years 1925 to 1935, inclusive, received from the Ross Corporation payments in Canadian dollars amounting to $1,452,783.46. Of this amount $900,500 received during 1925 to 1929, inclusive, was treated by both the petitioner and the Ross Corporation, together with $60,000 received in 1922, a year not before us, as representing a complete liquidation of the note for $960,500 which the Ross Corporation issued to petitioner in part consideration for the securities transferred to the corporation by petitioner in*1424 accordance with the April 27, 1922, agreement. The $386,400 received during 1930 to 1935, inclusive, was treated by both the petitioner and the Ross Corporation as representing a complete liquidation of the $386,400 purchase price of stocks and bonds transferred to the corporation by petitioner in accordance with the December 18, 1922, resolution. Petitioner contends that these two amounts of $900,500 and $386,400 must be held by the Board to constitute repayments of indebtedness by the corporation and *14 not the receipt of dividends by petitioner, as the respondent contends. Petitioner concedes that the balance of the $1,452,783.46 payments, amounting to $165,883.46 in Canadian dollars received in 1935, should be regarded as a dividend received by petitioner in that year from the Ross Corporation.
The respondent, in contending that the two amounts of $900,500 and $386,400 must also be regarded as dividends, does not contend that the separate entities of petitioner and the Ross Corporation should be disregarded. In his brief he sums up his argument on this issue as follows:
* * * It is not so much that the separateness of the corporate entity is to be ignored as that*1425 the form of the transaction with that corporation must be ignored and its substance given effect. * * * All the evidence in this case points with almost unescapable certainty to the conclusion that Ross Corporation was the petitioner's alter ego; one of his "two pockets". The supposed agreements of sale were nothing more than formal devices adopted for the purpose of facilitating shifting from one pocket to another. They should be ignored.
In other words, the respondent would have us hold that the two transactions in 1922 whereby petitioner transferred securities to the corporation in consideration for 20,000 shares of stock, a note for $960,500, and an open account for $386,400 to petitioner's credit, should be regarded as if petitioner merely transferred the securities in consideration for the shares of stock. We see no justification for such a holding. The facts do not support respondent's contention that the $960,500 and $386,400 in question represented "Nothing more than formal devices adopted for the purpose of facilitating shifting from one pocket to another." On the contrary, the evidence fully supports petitioner's contention that the amounts in question represented*1426 bona fide indebtedness owed to petitioner by the Ross Corporation. We think we must so treat it in the disposition of these proceedings.
Petitioner's counsel, who acted for him in the forming of the Ross Corporation, testified that he was entirely unfamiliar with section 119(a)(2)(B) of the Revenue Act of 1934 and similar provisions of earlier acts until April 23, 1937, when petitioner was first notified by the respondent of the proposed tax liability. This, it would seem, makes it unlikely that the manner in which petitioner organized the Ross Corporation by transferring securities to it in part consideration for capital stock and in part consideration for a note and an open account, and the later payment by the corporation to the petitioner of the corporation's indebtedness to petitioner, was in any way done with a view of avoiding any United States tax liability. If any doubt exists as to the correctness of such a statement, it seems that it would be dispelled by the recognition of the fact that if at *15 any time petitioner had known of the provisions of section 119(a)(2)(B) of the Revenue Act of 1934 or similar provisions of earlier acts he could have avoided their*1427 application entirely simply by transferring a sufficient amount of Canadian securities to the Ross Corporation so that the latter's gross income derived from sources within the United States would have been less than 50 percent of its gross income from all sources. The evidence shows that the gross income of the Ross Corporation from sources within the United States for all of the periods involved was only slightly over 50 percent, and that petitioner individually owned at all times large amounts of income-producing Canadian securities which he could easily have sold or transferred to the corporation.
After a careful consideration of the entire record, we are of the opinion and have so found as an ultimate fact as to this issue, that all payments received by petitioner from the Ross Corporation during the years 1925 to 1935, inclusive, with the exception of the dividend of $19,996 (Canadian money) in 1926 and payments aggregating $165,883.46 (Canadian money) in 1935, constituted payments in discharge of legal and binding obligations of Ross Corporation to petitioner instead of dividends. *1428 Carl G. Fisher,7 B.T.A. 968">7 B.T.A. 968; Herff & Dittmar Land Co.,32 B.T.A. 349">32 B.T.A. 349. Cf. Curran v. Commissioner, 49 Fed.(2d) 129. It follows that there are no deficiencies and no penalties due for the years 1925 and 1927 to 1934, inclusive.
In view of our holding in connection with the previous issue, the remaining issues are material only in so far as they affect the years 1926 and 1935.
To what extent, if any, should the 25 percent delinquency penalties be imposed for the years 1926 and 1935?
Since no return was filed for the year 1926, the imposition of the 25 percent penalty for that year is mandatory. Section 3176 of the Revised Statutes, as amended by section 1103 of the Revenue Act of 1926; Douglas L. Edmonds, Administrator,31 B.T.A. 962">31 B.T.A. 962; affd., 90 Fed.(2d) 14; certiorari denied, 302 U.S. 713">302 U.S. 713; Axel Holmstrom,35 B.T.A. 1092">35 B.T.A. 1092; Theodore R. Plunkett,41 B.T.A. 700">41 B.T.A. 700, 710; Vahram Chimchirian,42 B.T.A. 1437">42 B.T.A. 1437.
The question as to whether the 25 percent penalty should be added for the year 1935 is presented under somewhat different circumstances, *1429 but we think the result must be the same. The applicable statutory provision is section 291 of the Revenue Act of 1934. 2 The respondent *16 contends that we should regard the year 1935 as if no return had been filed, in which event the imposition of the penalty would likewise be mandatory. Petitioner contends, however, that we can not ignore the return filed on or about January 20, 1940; that this return must be regarded as a delinquent return; that the evidence shows that the failure to file the return on time was due to reasonable cause and not due to willful neglect; and that, therefore, no penalty should attach.
Petitioner's return for the year 1935 was due to be filed on or before June 15, 1936. Sec. 216, *1430 Revenue Act of 1934. No return was filed by petitioner for the year 1935 until on or about January 20, 1940, which was after the respondent on August 5, 1937, had made his determination of the deficiency for that year and after petitioner had on October 26, 1937, filed his petition with this Board and respondent had filed his answer thereto. Since January 20, 1940, is more than 150 days after June 15, 1936, section 406 of the Revenue Act of 1935 has no application here. On January 26, 1940, petitioner filed a motion for leave to file an amendment to his petition, in which amendment additional facts were alleged relating to the filing of the 1935 return. This motion was granted on January 29, 1940. In Taylor Securities, Inc.,40 B.T.A. 696">40 B.T.A. 696, we held that returns filed after the respondent had made his determination of deficiencies were insufficient to relieve the petitioner there of the mandatory operation of the statutory provisions imposing the 25 percent penalty.
In Theodore R. Plunkett, supra, we said:
* * * The purported income tax return of the petitioner for 1934 mailed by the petitioner from Adams, Massachusetts, on March 15, 1935, was*1431 not a return required by the statute. It was no return at all. The first return which was filed was filed on October 10, 1938. That return was filed after all pleadings in this case had been filed and issue joined. It was filed too late to avoid the attachment of the penalty. Taylor Securities, Inc., supra.
The action of the respondent in adding to the tax the 25 percent penalty for delinquency is approved.
Following the foregoing decisions, the Commissioner's action in determining a delinquency penalty of 25 percent against petitioner for the year 1935 is approved.
Even if we are in error in treating the return filed by petitioner on January 20, 1940, long after issue had been joined by the parties, as "no return" within the meaning of section 291, supra, and assuming that we should treat the return in question as a "delinquent return" within the meaning of that section, nevertheless, we think the result would be the same. The burden of proof would be on petitioner to show that his failure to file his return for the year 1935 at the time it was required by law was due to reasonable cause and not due to willful neglect. Petitioner has not made such*1432 a showing. All that he has proved in that respect is that he was *17 ignorant of the law which imposed such a tax and, therefore, filed no return under it. While that sort of a showing doubtless absolves him from "willful" neglect, it does not constitute "reasonable cause." See Charles E. Pearsall & Son,29 B.T.A. 747">29 B.T.A. 747; Rafael Sabatini,32 B.T.A. 705">32 B.T.A. 705; affd., 98 Fed.(2d) 753; Berlin v. Commissioner, 59 Fed.(2d) 996.
Is petitioner entitled to a credit for dividends received in computing his income subject to normal tax for the years 1926 and 1935, respectively? In his deficiency notice, the respondent did not determine any "normal tax" liability against petitioner for any year, but confined his determination to one of "surtax" liability. In his third amended answer to the petition as amended, the respondent affirmatively alleged "that in his deficiency notice he allowed as credits against net income for normal tax purposes the amount received as dividends in each of the years involved; the allowance of such credits was erroneous." Section 216 of the Revenue Act of 1926, in so far as material herein, provides*1433 as follows:
SEC. 216. For the purpose of the normal tax only there shall be allowed the following credits:
(a) The amount received as dividends * * * (2) from a foreign corporation when it is shown to the satisfaction of the Commissioner that more than 50 per centum of the gross income of such foreign corporation for the three-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the United States as determined under the provisions of section 217.
Section 217(g)(1) of the Revenue Act of 1926, in so far as material herein, provides as follows:
Except as provided in paragraph (2) a nonresident alien individual * * * shall receive the benefit of the deductions and credits allowed in this title only by filing or causing to be filed with the collector a true and accurate return of his total income received from all sources in the United States, in the manner prescribed in this title; including therein all the information which the Commissioner may deem necessary for the calculation of such deductions and credits. [Italics*1434 supplied.]
Petitioner did not file any return for the year 1926. In view of the plain provisions of section 217(g)(1), supra, it follows that, in computing the normal tax for the year 1926, petitioner is not entitled to any credit for dividends received from a foreign corporation which would otherwise be allowable under section 216(a)(2), supra.
Relative to the year 1935, it is sufficient to note that the Revenue Act of 1934, for the purpose of the normal tax, does not allow any credit for dividends from foreign corporations as does section 216(a)(2) of the Revenue Act of 1926 and section 25(a)(2) of the *18 Revenue Acts of 1928 and 1932, respectively. See sec. 25, Revenue Act of 1934. It follows that, in computing the normal tax for the year 1935, petitioner is not entitled to any credit for dividends received from a foreign corporation.
The final issue is whether that portion of the amounts received by petitioner from the Ross Corporation in 1926 and 1935, which we have under a previous issue held to be dividends, should be included in petitioner's income in terms of United States money at the rate of exchange existing at the time of receipt or at the rate*1435 existing at the end of the year. The payments which the respondent included in petitioner's income were included by him in terms of Canadian dollars, which was erroneous. The respondent's ruling O.D. 419, Cumulative Bulletin No. 2, p. 60, which we think correctly interprets the law, provides in full as follows:
Income returnable for the purpose of Federal taxes should be expressed in terms of United States money. The rate of exchange at the time of receipt governs in making the computation.
We hold as to this issue that the portion of the amounts received in Canadian dollars by petitioner in 1926 and 1935 which we have held to be dividends should be expressed in terms of United States money at the rate of exchange in force at the time of receipt. Upon this basis petitioner is taxable on dividends received in 1926 in the amount of $19,911.88 and on dividends received in 1935 in the amount of $163,966.57.
The deficiencies and penalties for the years 1926 and 1935 should be recomputed in accordance with this report. There are no deficiencies and no penalties for the years 1925 and 1927 to 1934, inclusive.
Reviewed by the Board.
Decision will be entered under Rule*1436 50.
LEECH, dissenting: I disagree with the conclusion of the majority on the first issue. This issue, decisive of the controversy, is disposed of wholly without discussion of the facts or the principles involved, upon the assertion that it is controlled by the decision of the Board in the Lord Forres case, 25 B.T.A. 154">25 B.T.A. 154. This conclusion is predicated upon a statement that the facts in the two cases are identical with one exception which is said to be immaterial. I think the record convincingly discloses that the facts in the two cases are radically different and that the Forres case is not controlling here.
In the years 1925 to 1935, inclusive, the Ross Corporation made payments in large amounts from its bank balances in Canada to petitioner. Respondent contends these payments were, in substance, *19 dividends from a foreign corporation. Upon this premise the disputed deficiencies and penalties were determined by taxing such "dividends" to petitioner as "income from sources within the United States" under the definition quoted in section 119(a)(2)(B) of the Revenue Act of 1934 1 and similar provisions in the prior applicable*1437 revenue acts. 2
Petitioner contests the validity of the proposed assessments upon several counts. His primary position is that the United States is without jurisdiction to tax him, a nonresident citizen of a foreign*1438 country, upon his receipt of income from a foreign corporation, taking place in a foreign country, the United States having no jurisdiction of his person or property.
Respondent argues that this contention confuses the power of the Government to impose the tax with its power to enforce payment. It is then said that it is the existence of the latter power, only, that is here subject to question, which thus requires us to redetermine the deficiencies by literal application of the statute, even though their collection be impossible. I agree that mere apparent inability to collect the tax would not affect the liability to pay it with which liability, alone, we can be concerned.
But here, contrary to the view of the majority, I think the primary question is whether the statutory provisions, supra, in so far as they affect the taxpayer here, were within the legislative jurisdiction of the Government. If such jurisdiction was lacking, then the liability falls with the statutory authority supporting it. McCulloch v. Maryland,4 Wheat. 316">4 Wheat. 316; *1439 Rose v. Himely, 4 Cranch, 241; The Appollon,9 Wheat. 362">9 Wheat. 362; St. Louis v. Ferry Co.,11 Wall. 423">11 Wall. 423; Dewey v. Des Moines,173 U.S. 193">173 U.S. 193; Whitney v. Commissioners of Inland Revenue, A.C. 37; City of New York v. McLean,170 N.Y. 374">170 N.Y. 374; 63 N.E. 380">63 N.E. 380. The supreme Court thus states the rule in St. Louis v. Ferry Co., supra:
Where there is jurisdiction neither as to person nor property, the imposition of a tax would be ultra vires and void. If the legislature of a State should enact that the citizens or property of another State or country should be taxed in the *20 same manner as the persons and property within its own limits and subject to its authority, or in any other manner whatsoever, such a law would be as much a nullity as if in conflict with the most explicit constitutional inhibition. Jurisdiction is as necessary to valid legislative as to valid judicial action.
In Dewey v. Des Moines, supra, the rule is again applied. In that case, Dewey, a citizen and resident of Illinois, filed a petition in the State Court*1440 of Iowa to have certain paving assessments on his lots in Des Moines set aside and to obtain an injunction enjoining any proceedings for the sale of such property and for a judgment that there was no personal liability upon him to pay the excess of the assessment over the amount realized upon the sale. The contractor who did the paving work, who was made a party to the proceeding, counterclaimed for a foreclosure of his lien upon the lots and for a personal judgment against Dewey. Under the statutes of Iowa the lot owner was made personally liable for the assessment. The Supreme Court specifically held that a state, in exercising its sovereign power of taxation, could not by legislation impose a personal liability upon a citizen and resident of another state for taxes on property located within the state, and that the imposition of such a liability constituted a violation of the due process clause of the Constitution. The Court stated:
* * * This plaintiff was at all times a non-resident of that State, and we think that a statute authorizing an assessment to be levied upon property for a local improvement, and imposing upon the lot owner, who is a non-resident of the State, a*1441 personal liability to pay such assessment, is a statute which the State has no power to enact, and which cannot therefore furnish any foundation for a personal claim against such non-resident. There is no course of reasoning as to the character of an assessment upon lots for a local improvement by which it can be shown that any jurisdiction to collect the assessment personally from a non-resident can exist. The State may provide for the sale of the property upon which the assessment is laid, but it cannot under any guise or pretense proceed farther and impose a personal liability upon a non-resident to pay the assessment or any part of it. To enforce an assessment of such a nature against a non-resident, so far as his personal liability is concerned, would amount to the taking of property without due process of law, and would be a violation of the Federal Constitution.
However, the limits of legislative jurisdiction, in our Constitution, have been clearly defined. Chief Justice Marshall, in Rose v. Himely, supra; said:
It is conceded that the legislation of every country is territorial; that beyond its own territory, it can only affect its own subjects*1442 or citizens.
St. Louis v. Ferry Co., supra; The Apollon, supra; Dewey v. Des Moines, supra;Shaffer v. Carter,252 U.S. 37">252 U.S. 37; Prof. Beale, Conflict of Laws, § 74.1; Whitney v. Commissioners of Inland Revenue, supra; Prof. Beale, 32 Harv.L.R. 587, 589-90; Black on Judgments, vol. 1, 2d Ed. § 227; Cooley on Taxation, 4th Ed., vol. 3, § 1333.
*21 These cases, and others, disclose the premises of those limitations. In Shaffer v. Carter, supra, the Supreme Court thus states:
* * * Governmental jurisdiction in matters of taxation, as in the exercise of the judicial function, depends upon the power to enforce the mandate of the State by action taken within its borders, either in personam or in rem according to the circumstances of the case, as by arrest of the person, seizure of goods or lands, garnishment of credits, sequestration of rents and profits, forfeiture of franchise, or the like; and the jurisdiction to act remains even though all permissible measures be not resorted to. * * *
The question as presented here seems to be novel. *1443 I can not find, nor has my attention been called to, any decision in point on the present facts. Though the taxpayer is a citizen and resident of Canada, he is entitled to the protection of the due process clause of the Fifth Amendment to the Constitution. See Lem Moon Sing v. United States,158 U.S. 538">158 U.S. 538; Downes v. Bidwell,182 U.S. 244">182 U.S. 244, and other cases therein cited. Thus if the United States had no such jurisdiction as to the taxpayer, either in personam or in rem, then the quoted statute and its prototypes in so far as they authorize the determination of the contested deficiencies against this taxpayer, fall, because violative, in such instances, of the Fifth Amendment to the Constitution. Dewey v. Des Moines, supra.And, if neither essential factual premise for legislative jurisdiction existed when the distributions occurred upon which the contested liabilities are said to have arisen, neither personal protests of the taxpayer to the respondent nor his appearance in this proceeding to contest the validity of those liabilities could retroactively supply the necessary original jurisdictional prerequisites*1444 and reinstate a liability which never existed. Shaffer v. Carter, supra;Dewey v. Des Moines, supra;City of New York v. McLean, supra.
Petitioner is and always has been a nonresident alien, a citizen and resident of the Province of Quebec, Canada. He has never resided in or carried on business in the United States and during all the period here involved has owned no property, real or personal, in the United States. Since its incorporation in 1922 he has owned all of the issued capital stock, except four qualifying shares, of the Ross Corporation, a Canadian corporation with its place of business in Conada, which has carried on no business in the United States. From 1922 to 1935, Ross Corporation owned certain stocks and bonds of corporations organized under the laws of the United States of the states or territories thereof and in each of those years the dividend and interest income it received therefrom constituted more than 50 percent of its gross income from all sources.
These earnings of the United States corporations, produced under the protection of the laws of the United States and while yet in this *22 *1445 country, were distributed in dividends and interest to the Ross Corporation. The source to that corporation of these dividends and interest was the United States. Thus at the time of their distribution from that source, when they represented credits due this foreign corporation, these earnings were within the jurisdiction of this country and subject to the exercise of its power to tax. The imposition of an income tax on such nonresident foreign recipient has been recognized as in the nature of the garnishment of a credit due it from the domestic corporation. The presence in the United States of the obligor or the obligee of that credit is said to support jurisdiction for the imposition of the tax. As stated by the Circuit Court of Appeals for the Second Circuit, in Commissioner v. Nevius, 76 Fed.(2d) 109 (certiorari denied, 296 U.S. 591">296 U.S. 591): "The United States has jurisdiction to tax when it can lay hold of either the obligor or the obligee of a chose in action. In the case of shares of stock, the corporation is the obligor." This jurisdiction in the United States over the payment on account of this credit existed at the time of its receipt by the*1446 foreign corporation, and the payment was thus received burdened with this obligation. De Ganay v. Lederer,250 U.S. 376">250 U.S. 376; Burnet v. Brooks,288 U.S. 378">288 U.S. 378; Commissioner v. Nevius, supra;Travis v. Yale & Towne Mfg. Co,252 U.S. 60">252 U.S. 60.
This same basis of jurisdiction, I think, was present in Lord Forres, supra, upon which case, alone, the conclusion of the majority on the first issue is supported. But the question of jurisdiction raised here was not and could not have been raised on the facts revealed in that case.
The majority says that "The only difference between the facts in the Lord Forres case and the facts in the instant proceeding is that in the Lord Forres case both the nonresident alien and the foreign corporation owned property in the United States, whereas in the instant proceeding, at the time of the hearing, neither the petitioner nor the Ross Corporation owned property of any value in the United States." Then follows their conclusion that this difference is insufficient to distinguish the two cases. I think that difference is important and may be sufficient, *1447 in itself, to afford a basis of jurisdiction in rem on the facts in the Lord Forres case which is wholly absent here. See Shaffer v. Carter, supra;Scottish Union & National Insurance Co. v. Boland,196 U.S. 611">196 U.S. 611; Nickey v. Mississippi,292 U.S. 393">292 U.S. 393.
That basis would, of course, not support the imposition of a judgment in personam, to which, I think, the Board is limited by statute. But that question became moot in the Lord Forres case since there the petitioner ceased, in effect, to be a nonresident alien by bringing himself personally under the jurisdiction of the United States. In that case the petitioner was and had been for some years a member *23 of a domestic partnership, actively carrying on a business under the protection of the laws of the United States. The petitioner had filed an income tax return to this Government, including only his share of that partnership income. He was contesting before the Board a deficiency in the tax on the income so returned. Jurisdiction to impose a personal judgment therefore existed in fact.
But, beyond that, the records in these two cases definitely*1448 disclose other and even more important factual differences. These can not, so easily, be ignored. The question presented to the Board in the Lord Forres case was whether, in addition to certain items of partnership income, the return should also have included dividends distributed to Forres from its earnings by a domesticated foreign corporation in which Forres was a stockholder. This fact most strikingly differentiates the Lord Forres case from that under discussion. The distributed earnings in question in the Lord Forres case were those of the Olympic Portland Cement Co., Ltd., from its cement business actually and actively carried on in the United States. Forres was a stockholder in that corporation. The earnings from which the taxed distributions were declared and paid were subject to the jurisdiction of the United States as and when there earned under the protection of its laws. When the contested dividends from those earnings were declared to Forres and the other shareholders, these dividends constituted choses in action or credits due Forres from a corporation over both the person and property of which this country then had jurisdiction. *1449 Commissioner v. Nevius, supra.
Here, the Ross Corporation was not in business in the United States. It was that corporation and not the petitioner, its shareholder, which owned the stock and bonds in the United States corporations, the earnings of which arose under the protection of the United States. In short, Lord Forres occupied exactly the same status in reference to the taxed income there that the Ross Corporation occupies here. The basis for jurisdiction to tax upon that status was exhausted when that corporation received the distribution of these earnings and removed them from the jurisdiction of the United States to Canada with no liabilities against such earnings other than those it has already admitted and paid.
However, respondent askes that we go further than the Lord Forres case. His position is not predicated upon the disregard of the entity of the Ross Corporation as separate from its shareholders. Indeed that entity must be recognized here. Rhode Island Trust Co. v. Doughton,270 U.S. 69">270 U.S. 69. Under Canadian law, found as a fact, it is so recognized. Respondent has already recognized and taxed it as such. Its recognition*1450 is implicit even in the statutory provision under which the present taxes were determined.
*24 The position of the respondent is that, because the origin of the earnings with which the dividends and the interest on the stocks and bonds owned by the Ross Corporation were paid was in the United States, they were then subject to the jurisdiction of the United States. It is then argued that, as a condition precedent to the removal of that income from this country, the United States had the jurisdiction to and in the statutes under consideration did attach to such income the condition that if and when, at any time in the future, this Canadian corporate recipient later distributed this income in Canada to this petitioning Canadian stockholder, such stockholder took it with the obligation to pay this additional tax. Counsel for respondent epitomized his argument thus: "The power to tax this incime when it comes into the hands of the stockholder flows not from any disregard, as I have said, of the corporate entity, but from the power of the Sovereign to control the future course of that which originates within its borders."
No authority is cited and I can find none supporting*1451 such a theory. In my judgment, this country can not project its tax laws beyond its territorial limits and thus create liabilities against foreign citizens to the United States as a result of transactions taking place in a foreign country, merely upon the ground that the subject matter of the tax, in some prior period, originated in the United States. The Ross Corporation could not obligate its shareholders. Vermont Loan & Trust Co. v. Gillis,282 U.S. 796">282 U.S. 796. Extraterritorial jurisdiction of the United States extends only to its citizens, since, as such, they alone receive the benefit of the protection of this country when resident in a foreign country. Rose v. Himely, supra; The Apollon, supra; Cook v. Tait,265 U.S. 47">265 U.S. 47.
Two recent decisions by the Supreme Court sustain that view. Both have to do with the taxing power of the state under the prohibition of the Fourteenth Amendment, but are, of course, in point here in determining the legislative jurisdiction of the Federal Government to lay a tax under the corresponding prohibition of the Fifth Amendment. The first case, *1452 Connecticut General Co. v. Johnson,303 U.S. 80">303 U.S. 80, denied the jurisdiction of the State of California to tax transactions by a foreign corporation taking place outside the state, although the corporation was licensed to do business in the state and the transactions were in connection with matters which had their origin there. The Court there said:
But the limits of the state's legislative jurisdiction to tax, prescribed by the Fourteenth Amendment, are to be ascertained by reference to the incidence of the tax upon its objects rather than the ultimate thrust of the economic benefits and burdens of transactions within the state. As a matter of convenience and certainty, and to secure a practically just operation of the constitutional *25 prohibition, we look to the state power to control the objects of the tax as marking the boundaries of the power to lay it. Hence it is that a state which controls the property and activities within its boundaries of a foreign corportion admitted to do business there may tax them. But the due process clause denies to the state power to tax or regulate the corporation's property and activities elsewhere. * * *
*1453 In the second case, Wisconsin v. Penney Co.,311 U.S. 435">311 U.S. 435, the Supreme Court of Wisconsin, on authority of Connecticut General Co. v. Johnson, supra, held a satute of that state in contravention of the Fourteenth Amendment in imposing a tax upon foreign corporations for the privilege of receiving and distributing dividends representing earnings derived from business carried on under license within the state. In reversing this decision and sustaining the validity of the statute the Supreme Court of the United States held the tax to be in effect an additional income tax laid on the foreign corporation which produced the income in Wisconsin and under the protection of its laws, the collection being merely delayed until the time of distribution of the income.
A reading of these cases, together with the dissent in the latter, I think, discloses that the contested legislation in the Penney case would not have been a constitutional exercise of the taxing power of the state if the tax had been imposed upon the shareholder and not the corporation.
Here the income tax is laid directly upon the stockholder and not the corporation and therefore*1454 is under the ban of that reasoning. This liability can not be held to be an income tax imposed upon earnings as and when derived in this country, and its collection merely deferred until distribution, as in the Penney case. This tax, a personal liability, is imposed by the statute upon that individual who, by reason of his ownership of the stock at the time of the taxed distribution, is in receipt of that distribution. Who that individual may be, is unknown until after the earnings have passed beyond the jurisdiction of the United States and, in the present case, happens to be a noneresident alien, carrying on no business and owning no property in the United States.
The title of the relevant provision in the 1934, 1932, and 1928 Revenue Acts is "Income from Sources Within United States." 3 However, despite that title, it will be noted that the tax which the acts in question seek to impose is not alone upon income as defined in that title, but upon the total distribution of income by the foreign corporation to a stockholder, irrespective of the source from which it was derived, if in the year of distribution, 50 percent or more of the net income of the *26 foreign*1455 corporation for the prior three years was derived from sources within the United States.
Petitioner is and always has been a nonresident alien. He has never carried on any business in the United States and, during all the years in review here, has owned no property in this country.
When the earnings of the United States corporations, which arose from sources in this country, were paid to the Ross Corporation, those earnings then lost their character as from those sources and became a part of the surplus in Canada of the Canadian corporation. They were thereafter used, not in the United States, but in Canada, to which country its business was limited. But no liabilities are said by the statutes to have arisen until the alleged dividend distributions by the Canadian corporation to the Canadian stockholder occurred. At that time the Canadian corporation was in possession, in Canada, of the payments from the United States corporations. Any credit or chose in action in favor of the petitioner, which thereafter arose because of that income, existed therefore only within*1456 the jurisdiction of Canada - not the United States. And neither the obligor nor obligee therein was within the jurisdiction of this country. See Commissioner v. Nevius, supra.
The taxpayer owned only stock in the Canadian corporation, the situs of which stock was Canada. Corry v. Baltimore,196 U.S. 466">196 U.S. 466. The distributions taxed here as dividends, if such, were those of the Canadian corporation from its surplus. The actual source of those distributions as to petitioner was Canada - not the United States. That source can not be changed merely by what I think is an arbitrary statutory definition. Rhode Island Trust Co. v. Doughton, supra.
I think that section 119(a)(2)(B) of the Revenue Act of 1934, and parallel sections of the earlier revenue acts, were ineffective in so far as they authorize the inposition of the contested liabilities, and that the deficiencies fall with the authority supporting their determination.
HARRON agrees with this dissent.
Footnotes
1. SEC. 119. INCOME FROM SOURCES WITHIN UNITED STATES.
(a) GROSS INCOME FROM SOURCES IN UNITED STATES. - The following items of gross income shall be treated as income from sources within the United States:
* * *
(2) DIVIDENDS. - The amount received as dividends -
* * *
(B) from a foreign corporation unless less than 50 per centum of the gross income of such foreign corporation for the three-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the United States as determined under the provisions of this section; but dividends from a foreign corporation shall, for the purposes of section 131 (relating to foreign tax credit), be treated as income from sources without the United States. ↩
2. SEC. 291. FAILURE TO FILE RETURN.
In case of any failure to make and file a return required by this title, within the time prescribed by law or prescribed by the Commissioner in pursuance of law, 25 per centum of the tax shall be added to the tax, except that when a return is filed after such time and it is shown that the failure to file it was due to reasonable cause and not due to willful neglect no such addition shall be made to the tax. * * * ↩
1. SEC. 119. INCOME FROM SOURCES WITHIN UNITED STATES.
(a) GROSS INCOME FROM SOURCES IN UNITED STATES. - The following items of gross income shall be treated as income from sources within the United States:
(2) DIVIDENDS. - The amount received as dividends -
(B) from a foreign corporation unless less than 50 per centum of the gross income of such foreign corporation for the three-year period ending with the close of its taxable year preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) was derived from sources within the United States as determined under the provisions of this section; but dividends from a foreign corporation shall, for the purposes of section 131 (relating to foreign tax credit), be treated as income from sources without the United States;
* * * ↩
2. Sec. 119(a)(2)(B), Revenue Act of 1932; sec. 119(a)(2)(B), Revenue Act of 1928; sec. 217(a)(2)(B), Revenue Act of 1926. ↩
3. The title of the relevant provision in the 1926 Act is "Net Income of Nonresident Alien Individuals." ↩