decided: January 5, 1931.
WILLCUTS, COLLECTOR OF INTERNAL REVENUE
CERTIORARI TO THE COURT OF APPEALS FOR THE EIGHTH CIRCUIT.
Hughes, Holmes, Van Devanter, McReynolds, Brandeis, Sutherland, Butler, Stone, Roberts
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MR. CHIEF JUSTICE HUGHES delivered the opinion of the Court.
The respondent, Charles W. Bunn, in the years 1919 and 1920, purchased for cash, as investments, bonds issued by various counties and cities in the State of Minnesota. In January, 1924, he sold these bonds, realizing a net profit of $736.26. Upon this net profit, less a net loss of $41.20 suffered by him on similar bonds held less than two years, the Commissioner of Internal Revenue determined an additional income tax in the amount of $85.44. The plaintiff paid this amount to the Collector, under protest, and claimed a refund upon the ground that the tax was illegal because assessed upon income from municipal bonds. The claim was rejected and this suit was brought against the Collector to recover the money paid.
The complaint, alleging these facts, charged that the Revenue Act of 1924, if thus applied, was unconstitutional and void in that the tax was laid upon the instrumentalities of States. Demurrer to the complaint was overruled by the District Court, and, the defendant having declined to plead further, judgment was entered for the plaintiff. The judgment was affirmed by the Circuit Court of Appeals, and this Court granted a writ of certiorari.
The Revenue Act of 1924 (c. 234, sec. 213, 43 Stat. 253, 267, 268, U. S. C. Tit. 26, sec. 954) clearly authorized the
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tax. The Act included in the term "gross income" the gains and profits derived from "sales, or dealings in property, whether real or personal." See Irwin v. Gavit, 268 U.S. 161, 166. The Act gave an express exemption to "interest upon the obligations of a State, Territory or any political subdivision thereof," but this exemption was not extended to profits realized on the sale of such obligations, and the statement of the Government is not challenged that it has been the uniform practice of the Treasury Department in administering the federal income tax acts to include in taxable income the gain derived from the sale of state and municipal bonds.
The authority of the Congress to lay a tax on the profit realized by an investor from the sale or conversion of capital assets in general is not open to dispute and is not disputed. That is a matter of governmental policy and not of constitutional power.*fn1 The question raised here is not because the securities sold were capital assets but because they were governmental in character.
The question is further limited by the fact that it does not appear that the securities were issued at a discount, so that the gain derived could be considered to be in lieu of interest. Whatever questions might arise in cases of that sort are not now before the court.*fn2 The present case is simply one of profit obtained from purchase and sale, without qualification by any special circumstances.
The well-established principle is invoked that a tax upon the instrumentalities of the States is forbidden by
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the Federal Constitution, the exemption resting upon necessary implication in order effectively to maintain our dual system of government.*fn3 The familiar aphorism is "that as the means and instrumentalities employed by the General Government to carry into operation the powers granted to it are exempt from taxation by the States, so are those of the States exempt from taxation by the General Government." Ambrosini v. United States, 187 U.S. 1, 7. And a tax upon the obligations of a State or of its political subdivisions falls within the constitutional prohibition as a tax upon the exercise of the borrowing power of the State. Pollock v. Farmers' Loan & Trust Company, 157 U.S. 429, 584-586; id., 158 U.S. 601, 618; National Life Insurance Company v. United States, 277 U.S. 508, 521.
The limitation of this principle to its appropriate applications is also important to the successful working of our governmental system. The power to tax is no less essential than the power to borrow money, and, in preserving the latter, it is not necessary to cripple the former by extending the constitutional exemption from taxation to those subjects which fall within the general application of non-discriminatory laws, and where no direct burden is laid upon the governmental instrumentality, and there is only a remote, if any, influence upon the exercise of the functions of government. This distinction has had abundant illustration. Thus, while the salary of an officer of the State cannot be taxed by the Federal Government, the compensation paid by a State or a municipality to a
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consulting engineer, who is neither an officer nor an employee of government, for work on public projects, may be subjected to a federal income tax. Metcalf & Eddy v. Mitchell, 269 U.S. 514, 524. No constitutional implications prohibit a non-discriminatory tax upon the property of an agent of government merely because it is the property of such an agent and used in the conduct of the agent's operations and necessary for the agency. McCulloch v. Maryland, 4 Wheat. 316, 436; Railroad Company v. Peniston, 18 Wall. 5, 33; Central Pacific Railroad Company v. California, 162 U.S. 91, 126; Baltimore Shipbuilding Company v. Baltimore, 195 U.S. 375, 382; Choctaw, Oklahoma & Gulf Railroad Company v. Mackey, 256 U.S. 531, 537. The Congress may tax state banks upon the average amount of their deposits, although deposits of state funds by state officers are included. Manhattan Company v. Blake, 148 U.S. 412. Both the Congress and the States have the power to tax transfers or successions in case of death, and this power extends to the taxation by a State of bequests to the United States, and to the taxation by the Congress of bequests to States or their municipalities. United States v. Perkins, 163 U.S. 625; Snyder v. Bettman, 190 U.S. 249, 253, 254.
In the case of the obligations of a State or of its political subdivisions, the subject held to be exempt from federal taxation is the principal and interest of the obligations. Pollock v. Farmers' Loan & Trust Company, supra. These obligations constitute the contract made by the State, or by its political agency pursuant to its authority, and a tax upon the amounts payable by the terms of the contract has therefore been regarded as bearing directly upon the exercise of the borrowing power of the government. In Weston v. Charleston, 2 Pet. 449, 468, 469, where the tax, laid under an ordinance of the city council upon United States stock which had been issued for loans made to the United States, was held invalid, the principle was
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thus stated by Chief Justice Marshall: "The right to tax the contract to any extent, when made, must operate upon the power to borrow, before it is exercised, and have a sensible influence on the contract. The extent of this influence depends on the will of a distinct government. To any extent, however inconsiderable, it is a burden on the operations of government. . . . The tax on government stock is thought by this Court to be a tax on the contract, a tax on the power to borrow money on the credit of the United States, and consequently, to be repugnant to the constitution." This language was applied by the Court in Pollock v. Farmers' Loan & Trust Company, supra (157 U.S. at p. 586) in holding invalid federal taxation "on the interest" from municipal securities.
But it does not follow, because a tax on the interest payable on state and municipal bonds is a tax on the bonds and therefore forbidden, that the Congress cannot impose a non-discriminatory excise tax upon the profits derived from the sale of such bonds. The sale of the bonds by their owners, after they have been issued by the State or municipality, is a transaction distinct from the contracts made by the government in the bonds themselves, and the profits on such sales are in a different category of income from that of the interest payable on the bonds. Because the tax in question is described as an "income tax" and the profits on sales are included in "income," the distinction is not lost between the nature of a tax applied to interest and that of a tax applied to gains from sales. The federal income tax acts cover taxes of different sorts. Brushaber v. Union Pacific Railroad Company, 240 U.S. 1, 17; Stanton v. Baltic Mining Company, 240 U.S. 103, 114. The tax upon interest is levied upon the return which comes to the owner of the security according to the provisions of the obligation and without any further transaction on his part. The tax falls upon the owner by virtue of the mere fact of ownership, regardless
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of use or disposition of the security. The tax upon profits made upon purchases and sales is an excise upon the result of the combination of several factors, including capital investment and, quite generally, some measure of sagacity; the gain may be regarded as "the creation of capital, industry and skill." Tax Commissioner v. Putnam, 227 Mass. 522, 531.
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The tax not being on the obligations of the State or municipality, or on the investment therein, as such, the question is whether the tax must nevertheless be held to be invalid because sales by investors are to be deemed inseparably connected with the exercise of the borrowing power of the State. When the Constitution prohibits States from laying duties on imports, the prohibition not only extends to a tax upon the act of importing, but also to one upon the occupation of the importer or upon the articles imported. A tax on the sale of an article, imported only for sale, is a tax on the article itself. Brown v. Maryland, 12 Wheat. 419, 444. Similarly, with respect to federal taxation of articles exported from any State, the constitutional inhibition gives immunity to the process of exportation and to the transactions and documents embraced in that process. Fairbank v. United States, 181 U.S. 283; United States v. Hvoslef, 237 U.S. 1; Thames & Mersey Marine Insurance Company v. United States, 237 U.S. 19. Only on that construction can the constitutional safeguard be maintained. Again, when the United States has assumed duties with respect to Indian lands, a State cannot impose an occupation or privilege tax on operations conducted in or upon such lands by lessees who have been constituted federal instrumentalities for the purpose of discharging the Government's obligation, Choctaw, Oklahoma & Gulf Railroad Company v. Harrison, 235 U.S. 292, 298, or upon the leases themselves or capital stock representing them, Indian Territory Illuminating Page 229} Oil Company v. Oklahoma, 240 U.S. 522, 530, or upon the net income of such a lessee, Gillespie v. Oklahoma, 257 U.S. 501, 504. See, also, Jaybird Mining Company v. Weir, 271 U.S. 609, 612.*fn4 These cases are not analogous to the one under consideration. If the tax now in question is to be condemned, it must be because of practical consequences and not because purchases and sales by private owners of state and municipal bonds are a part of the State's action in borrowing money. It would be far-fetched to say that such purchases and sales are instrumentalities of the State. They are not transactions made directly or indirectly in behalf of the State or in the course of the performance of any duty of the State. Sales are merely methods of transferring title to the obligation, that is, the right to receive performance of the promise of the State or municipality.
That a transfer of government bonds is not inseparably connected with the exercise of the Government's borrowing power so as to make the transfer per se immune from taxation is clearly demonstrated by the decisions upholding non-discriminatory taxation laid upon the transmission of such securities upon the death of the owner. This Court has decided that a State may lay a transfer tax upon a legacy although it consists entirely of bonds of the United States, Plummer v. Coler, 178 U.S. 115, and that the Congress may tax the transfer of the net assets of a decedent's estate although municipal bonds are included in determining the net value, Greiner v. Lewellyn, 258 U.S. 384. In Plummer v. Coler, supra (p. 125), the tax of the State was sustained, despite the provision of the Act of Congress under which the bonds were issued that they should be exempt "from taxation in any form by or under State, municipal, or local authority." Id., pp. 134,
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; Act of July 14, 1870, c. 256, sec. 1, 16 Stat. 272; Rev. Stat., sec. 3701; U. S. C., Tit. 31, sec. 742. See, also Orr v. Gilman, 183 U.S. 278, 289; Blodgett v. Silberman, 277 U.S. 1, 12, 13. And in Greiner v. Lewellyn, supra (p. 387), the Court said that "the estate tax . . . like the earlier legacy or succession tax, is a duty or excise, and not a direct tax like that on income from municipal bonds. Pollock v. Farmers' Loan & Trust Company, supra. . . . Municipal bonds of a State stand in this respect in no different position from money payable to it. The transfer upon death is taxable, whatsoever the character of the property transferred and to whomsoever the transfer is made. It follows that in determining the amount of decedent's net estate municipal bonds were properly included." On similar grounds, as the Federal Government has power to tax transfers of property by gift inter vivos, Bromley v. McCaughn, 280 U.S. 124, there would seem to be no question of its constitutional authority to include in such taxation gifts of state or municipal securities.
It is urged, however, that a federal tax on the profits of sales of such securities should be deemed, as a practical matter, to lay such a burden on the exercise of the State's borrowing power as to make it necessary to deny to the Federal Government the constitutional authority to impose the tax. No facts as to actual consequences are brought to our attention, either by the record or by argument, showing that the inclusion in the federal tax of profits on sales of state and municipal bonds casts any appreciable burden on the States' borrowing power. We are left to the inadequate guidance of judicial notice. It may be considered to be a matter of common knowledge that the bonds of States and their municipalities are for the most part purchased for investment. But while, in the language of the tax act regarding deductions for losses, the purchase of municipal bonds for investment, as in the
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case of other investments, may be regarded as "entered into for profit" as distinguished from mere personal use, it may be doubted whether the prospect on the part of the ordinary investor of obtaining profit on the resale of such obligations is so important an element in inducing their acquisition that a federal tax laid on such profits, in common with profits derived from the sales of other property, constitutes any substantial interference with the functions of state governments. While the tax is laid on gains, there is also a deduction for losses on sales, and whether investors in such securities would consider it an advantage if both provisions were eliminated is a matter of mere speculation. It must be remembered that we are dealing, not with any express constitutional restriction, but only with an asserted implication. The constitutional provisions authorizing the Congress to lay taxes (Article I, Section 8; Sixteenth Amendment) are certainly broad enough to cover the tax in question, and before we can restrict their application upon the ground of a burden case upon the State's borrowing power, where the tax is not laid upon the contracts made by the State in the exercise of that power, or upon the amounts payable thereunder, but is laid upon the result of distinct transactions by private owners, it must clearly appear that a substantial burden upon the borrowing power of the State would actually be imposed. But we have nothing but assertion and conjecture. The assertion might as easily be made as to the necessity of the complete immunity of such securities from federal taxation in the case of estate taxes, and, if mere conjecture were sufficient as to the possibility of a burden being cast by the tax on the essential authority of the State, it could be as readily entertained in the one case as in the other. Indeed, the existence of the illegal burden might be more easily assumed in the case of the estate tax, where the entire value of the securities, and not merely gains on sales, are taken into the reckoning in determining the amount of the tax.
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There is, however, an outstanding fact, more important than any possible conjecture. That fact is found in uniform and long-established practice. This practice clearly indicates that neither the Federal Government nor the States have found a tax on the profits of the sales of their securities to be a burden on their power to borrow money. So far as we are advised, the Federal Government has not at any time deemed it to be necessary to exempt from taxation the profits realized by owners on the sale of its obligations, with the exception, recently made, of short-term Treasury bills issued on a discount basis and payable without interest.*fn5 Such profits are included in the general
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phrase "gains, profits and income" from "sales, or dealings in property," in the Act under consideration. And we understand that under all federal income tax acts, these or similar words have been construed invariably by the administrative authorities as including profits derived from the sale of state and municipal bonds. The present case appears to be the first in which the tax in this respect has been assailed. No State has ever appeared at the Bar of this Court to complain of this federal tax, and it is not without significance that in the present instance the
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States of New York and Massachusetts do appear here as amici curiae in defense of the tax.*fn6
The history of income tax legislation is persuasive, if not controlling, upon the question of practical effect. Plummer v. Coler, supra, (pp. 137, 138). Before the power of the Congress to lay the excise tax in question can be denied in the view that it imposes a burden upon the States' borrowing power, it must appear that the burden is real, not imaginary; substantial, not negligible. We find no basis for that conclusion, nor any warrant for implying a constitutional restriction to defeat the tax.
35 F.2d 29, reversed.