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Question 6: Income would be a gain profit, something of exchangeable value, proceeding from the property, severed from the

capital. Explain. Introduction: The gain derived from capital, from labor or effort, or both combined, including profit or gain through sale or conversion of capital. Income is not a gain accruing to capital or a growth in the value of the investment, but is a profit, something of exchangeable value, proceeding from the property and being received or drawn by the recipient for separate use, benefit, and disposal. In businesses, income can refer to a company's remaining revenues after all expenses and taxes have been paid. The modern concept of income comes not from the earliest part of the century, but instead from the 1955 Supreme Court decision in Glenshaw Glass v. Commissioner.1 The issue in Glenshaw was whether then section 22(a) of the 1939 Internal Revenue Code2 authorized Congress to tax punitive damages awarded to the Glenshaw Glass Company in a prior anti-trust settlement.3 Although the case dealt solely with statutory construction, the Court noted that the statutes language was used by Congress to exert in the *income tax+ field the full measure of its taxing power.4 In essence, the Court acknowledged, in sharp contrast to Macombers more limited definition, that the residual catch-all phrase of the statute,5or gains or profits and income derived from any source whatever, evidenced the intention of Congress to tax all gains except those specifically exempted.6

Id.; see also Dodge, supra note 45, at 15 (*Glenshaw+ is considered a watershed case ushering in the modern era in thinking about income issues.). Glenshaw is actually a collection of two cases regarding the taxability of punitive damages: Commissioner v. Glenshaw Glass Co. and Commissioner v. William Goldman Theatres, Inc.

I.R.C. 22(a) (1939) (Gross income includes gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid . . . or profits and income derived from any source whatever.). I.R.C. 22(a) (1939)s successor, I.R.C. 61(a) (2000), states that gross income means all income, from whatever source derived. 3 Glenshaw Glass Co., 348 U.S. at 427.
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Id. at 429 (citing Helvering v. Clifford, 309 U.S. 331, 334 (1940)). I.R.C. 22(a) (1939). Glenshaw Glass Co., 348 U.S. at 430 (emphasis added)

The legal Definition of income: The net income of a taxable person shall include gains, profits, and income derived from salaries, wages, or compensation for personal services of whatever kind and in whatever form paid, or from professions, vocations, business, trade, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in real or personal property, also from business carried on for gain or profit, or gains or profits and income derived from any source whatever, including the income from but not the value of property acquired by gift, bequest, devise, or descent. Nevertheless, because the general population effectively ratified the Sixteenth Amendment, common usage was the criterion on which the majority decided the stock dividend question and also the criterion on which the four dissenting Justices based their dissents. (The virtually even split provided a good reflection of the common mans opinion.) Pitney wrote that after examining dictionaries in common use, we find little to add to the succinct definition adopted in two cases arising under the Corporation Tax Act of 1909 Income may be defined as the gain derived from capital, from labor, or from both combined, provided that it be under- stood to include profit gained through a sale con- version of capital assets.7 In placing his emphasis on the word de- rived, Pitney said: Here we have the essential matter: not gain accruing to capital, not growth or increment of value in the investment; but a gain, a profit, something of exchangeable value proceeding from the property, 8severed from the capital however invested or employed, and coming in, being derived, that is, received or drawn by the recipient (the taxpayer) for his separate use, benefit and disposal; that is income derived from property. Nothing else answers the description [of income].9

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Eisner v. Macomber, p. 207. Pitney J., in Eisner v. Macomber 252 US 189 at pp 206, 207, defined income from property in following terms Eisner v. Macomber, p. 207.

The relationship between capital and income: Capital is the goods (or services) used to produce a good or service (which might be used to produce income). For example, a slicing machine might be the capital to produce crisps, which when sold creates 'income'. It can be human capital, which is labor from people. Income is the amount of money you receive, like a wage or salary, or the profit from a business. Capital and Income about the distinction between capital and income with regard to time became part of accepted economic wisdom. Capital is the stock of wealth that exists at an instant of time. This stock, when reckoned in its broadest sense, includes human beings. Income is a measure of wealth represented by the flow, through a period of time, of the uses of (or services provided by) capital. This flow of uses (income) is what allows people to value their capital at any given point in time. If a motion picture of the economy were stopped in freezeframe, the frame would reveal capital and nothing else. The frame would show everything from factories to the uneaten fruit on someones kitchen table. Capitalization means that people adjust their evaluation of the worth of the stream of services (income) through time. Capital has value to people (and therefore represents wealth) only because it offers a flow of valuable uses or services to people. The price someone is willing to pay for an article (or the property rights to an article), whether in money or in barter, is the capitalized (discounted) value of the expected services from the article. These services are discounted over time based on distant-term services and
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an individuals preferences for the flow of near-term versus

the risk and uncertainty associated with actually enjoying the

services expected in the future. Despite Fishers clarity, his definition of income as strictly the services from capital was not as well accepted as his general time distinction between capital and income. His arguments, perhaps because of their novelty, failed to dis- place the age-old confusion over capital and in- come; and his scientifically consistent definition of income could not overcome the force of common usage of the term income.


Ibid., pp. 513-14. Fishers thoughts in this area clearly benefited from correspondence with British economist Edwin Cannan. See Cannans What is Capital? The Economic Journal, Vol. 7 (1897), p. 284. 11 Irving Fisher, The Nature of Capital and In- come (New York: The Macmillan Co., 1912), p. 57. Italics in original.

Capital and income are not purely legal conceptions. They arise in trade and business and in all borrowings and lendings. What may be capital item in the accounts of one taxpayer might, in the particular circumstances of another, bear an income character. Thus, land though capable of producing income to be taxed as income from property, is itself usually capital in the hands of a non-trader. This holds good for a trader or a trading company if the trade is not that of a builder or land developer. If that is the trade, the land forms part of stock-in-trade and its cost counts as a trading expense.12 Capital expenditure and income expenditure: In a rough way, the criterion of what is capital expenditure as against what is income expenditure would be to say that capital expenditure is a thing that is going to be spent once and for all, and income expenditure is a thing that is going to recur every year. The contrasting phrase used by Lord Dunedin - expenditure once for all - is illustrated by the decision in Ounsworth v. Vickers Ltd. [1995] 3 KB 267, where the cost to a shipbuilding company of dredging a channel and providing a deep water berth for the construction and delivery of a ship was held to be capital expenditure. On the other hand, expenditure on stock in trade or other circulating capital is recurrent, and is accordingly a revenue item.13 Furthermore, a payment made for acquiring or creating a fixed asset or an amount received on its realization is usually a capital sum. The most obvious instance is that of the price received or paid on the sale or purchase of a capital asset of a physical or transferable kind, provided that the thing sold or acquired is not something in which it is the business of the particular taxpayer to deal. When an expenditure is made, not once and for all, but with a view to bringing into existence an asset or advantage for enduring benefit of a trade, then, in absence of indication to the contrary, such an expenditure is properly attributable to capital and not to revenue. The benefit should endure in the way that a fixed capital endures; but

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(Macnaghten J. in Johnson (Inspector of Taxes) v. Try (W.S.) Ltd. [1946] All ER. 165, affirmed in [1946] 1 All ER. 532)

(Lord Dunedin in Vallambrosa Rubber Co. Ltd. v. Farmer (Surveyor of Taxes) [1910] SC 579, 5T.C. 529 - See Simons Income Tax Vol.I, pr.45).

enduring does not mean everlasting. Moreover, the advantage need not be of a positive character. It may consist in getting rid of an item of fixed capital that is onerous.

The precise meaning of these expressions requires further explanation:

(a) What is a gain, a profit, something of exchangeable value? At first sight it would seem that the value of a commodity is a thing quite relative, and not to be settled without considering one commodity in its relations to all other commodities. In fact, in speaking of the value, the value in exchange of a commodity, we mean the proportional quantities in which it exchanges with all other commodities. But then asked the question: How are the proportions in which commodities exchange with each other regulated? We know from experience that these proportions vary infinitely. Taking one single commodity, wheat, for instance, we shall find that a quarter of wheat exchanges in almost countless variations of proportion with different commodities. It must be possible to express, in a very different form, these various equations with various commodities. As the exchangeable values of commodities are only social functions of those things, and have nothing at all to do with the natural qualities, we must first ask: What is the common social substance of all commodities? It is labor. To produce a commodity a certain amount of labor must be bestowed upon it, or worked up in it. And I say not only labor, but social labor. A man who produces an article for his own immediate use, to consume it himself, creates a product, but not a commodity. As a self-sustaining producer he has nothing to do with society. But to produce a commodity, a man must not only produce an article satisfying some social want, but his labor itself must form part and parcel of the total sum of labor expended by society. It must be subordinate to the division of labor within society. It is nothing without the other divisions of labor, and on its part is required to integrate them.

However, the requirement that there be a gain, profit or something of exchangeable value, may potentially be satisfied even where the issued rights are not directly converted into cash (for example, because of a contractual bar on trading in the rights). Thus, in Abbot v Philbin14, the majority of the House of Lords in considering the meaning of "all profits and perquisites whatsoever" derived from employment, found that options (which could not be traded) to purchase shares (which could be traded) were "capable of being turned to pecuniary account by being exercised, acquiring the shares and immediately selling them" and the "fact that there was no realization in the sense of actual turning into money is irrelevant".15 (b) What will constitute the separate use, disposal or benefit of the taxpayer? Similarly, the terms use, disposal or benefit would appear broad enough to support the taxing of a right as income, even where the right cannot be traded. However, the requirement that the right be capable of separate use, disposal or benefit would appear to limit the income character of rights to those that can be turned to account in some way other than their exercise to redeem the very shares from which they proceeded (i.e. by trading). (c) What is required for a derivation, receipt, drawing or coming in? In the United States "income" requires the "realization" of a gain. However, it appears to be the majority's finding in McNeil, and is consistent with earlier case law, that the derivation, receipt, drawing or coming in of the income occurred when the sell-back rights where issued to Custodial and that their character as income did not depend on the subsequent turning of the SBRs to pecuniary account on sale by CSFB. So much would seem implicit in the quantification of the "income" as the value of the sell-back rights when they were issued, and the finding that the increase in value between the issue price and sale price was a capital gain (and therefore, by implication, could not have been income because otherwise section 118-20 would have applied to reduce the capital gain to zero). The majority judgment does not directly address this question. However, it concludes:

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Abbot v Philbin [1960] 2 All ER 763. Ibid., per Viscount Simonds, at 767.

On the listing date, when the taxpayer's sell-back rights were granted by SGL to Custodial 'for the absolute benefit' of the taxpayer there was a derivation of income by her represented by the market value of her rights of $514 [ cf Abbot v Philbin [1961] AC 352]. That conclusion makes it unnecessary to consider the income nature of the receipt of the proceeds on 2 April 2001. 16 (d) What does "proceeding from the property" require? An issue of rights to a shareholder may be characterized as ordinary income where it "proceeds from the property". This would appear to require only that the shareholder receives the rights by reason of being a shareholder and not for some un-connected reason. (e) When will a right issued to shareholders be "severed" from their shareholdings? It is clear that the rights issued must be severed in some way from the property (shares) from which they are derived. In applying this definition in characterizing the sell-back right issued to Mrs McNeil, the majority rejected analogies between established case law dealing with (a) returns of capital and liquidation and (b) the pro-rata issue of bonus shares. These distinctions throw some light on the requirement of "severance". Returns of capital and liquidation surrender of a capital asset The majority rejected the argument of the taxpayer that "the Commissioner in speaking of the sell-back rights as severed or detached from the taxpayer's shares *erroneously+ conflated two rights, the 'general right' to returns of capital, this 'being part of the variety of rights making up the share', on the one hand, and the grant by [St George] of the sell-back rights in 'effectuation' of the foregoing 'general right'." What the taxpayer appears to have meant by this submission is that an unusual "effectuation" of the "general right" to a return of capital should be treated under the taxation law in the same manner as a direct return of capital.


3 at para. 51.

In rejecting this analogy, the majority made much of the view that Mrs McNeil's shareholding in St George "remained untouched" as a result of the transactions, and that her rights and entitlements under the buy-back arrangements were "generated by the execution of covenants in deeds poll" and did not "represent any portion of her rights as a shareholder under the constitution of [St George]". On this basis, the majority distinguished, as providing "no analogy", the "liquidation and informal distribution cases beginning with Stevenson".17 These cases include Thornett, in which, in a passage quoted by the majority in McNeil, Latham CJ held "that what [a cancellation of shares in return for a payment of cash and company assets] 'really amounted' to was 'a surrender by a shareholder of all capital interest in the company in return for a lump sum payment'".18 Profits a prendre: The majority also expressly rejected an analogy drawn by Dowsett J19 with a payment received to create profits a prendre over land.20 Implicitly the majority also rejected the relevance of other analogies proposed by Dowsett J which support treating the sell-back rights as a return of capital in the hands of the taxpayer; namely payments received by a taxpayer on its agreeing to give up part of it profit-earning structure21, the sale of an asset substituted for the right to receive interest22, and compensation for the compulsory acquisition of a partial interest in an asset or land. The majority judgment makes these distinctions in order to demonstrate that the character of the SBRs was not analogous to the character of these receipts. The majority judgment

therefore indicates what the issues are, but it does not necessarily tell us which were decisive,

Those cases cited included: Commissioner of Taxation (NSW) v Stevenson (1937) 59 CLR 80, Thornett v Federal Commissioner of Taxation (1938) 59 CLR 787, Federal Commissioner of Taxation v Blakely (1951) 82 CLR 388, Federal Commissioner of Taxation v Uther (1965) 112 CLR 630, and Federal Commissioner of Taxation v Slater Holdings Ltd (1984) 156 CLR 447. 18 Thornett v Federal Commissioner of Taxation (1938) 59 CLR 787.
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Supra, Note 2.

Which has been treated by the High Court as a capital receipt on the disposal of part of the vendor's interest in the land: Thomson v Deputy Commissioner of Taxation (Cth) (1929) 43 CLR 360. 21 For which Dowsett J cited Montgomery and Dickenson v Commissioner of Taxation (Cth) (1957) 98 CLR 460

For which Dowsett J cited Inland Revenue Commission v Paget [1938] 2 KB 25.

or why. McNeil therefore represents guidance from the High Court that the tax profession is on the wrong track in this area, but it remains less than clear which way the right track lies, or when we moved from one to the other. Conclusion: If then, speaking broadly, and embracing somewhat longer periods, all descriptions of commodities sell at their respective values, it is nonsense to suppose that profit, not in individual cases; but that the constant and usual profits of different trades spring from the prices of commodities, or selling them at a price over and above their value. The absurdity of this notion becomes evident if it is generalized. What a man would constantly win as a seller he would constantly lose as a purchaser. It would not do to say that there are men who are buyers without being sellers or consumers without being producers. What these people pay to the producers, they must first get from them for nothing. If a man first takes your money and afterwards returns that money in buying your commodities, you will never enrich yourselves by selling your commodities too dear to that same man. This sort of transaction might diminish a loss, but would never help in realizing a profit. To explain, therefore, the general nature of profits, you must start from the theorem that, on an average, commodities are sold at their real values, and that profits are derived from selling them at their values, that is, in proportion to the quantity of labor realized in them. If you cannot explain profit upon this supposition, you cannot explain it at all. This seems paradox and contrary to every-day observation. It is also paradox that the earth moves round the sun, and that water consists of two highly inflammable gases. Scientific truth is always paradox, if judged by every-day experience, which catches only the delusive appearance of things.

BIBLIOGRAPHY 1. Irving Fisher, The Income Concept in Light of Experience, English reprint, New Haven, Conn., 1927, p. 17. 2. Irving Fisher, What is Capital? The Economic Journal, Vol. 6, December, 1896, p. 509. 3. Fisher, the Nature of Capital and Income, p. 110. 4. Professor F. Patrick Hubbards article, Making People Whole Again: The Constitutionality of Taxing Compensatory Tort Damages for Mental Distress, 49 FLA. L. REV. 725 (1997) 5. BENJAMIN FRANKLIN VOL. X 69 (Albert Henry Smyth ed., Norwood Press 1907) (1789). 6. Schumtz, George I., Condemnation Appraisal Handbook , (Englewood Cliffs, NJ: Prentice Hall, 1963), p. 163. 7. Duvall, Richard O. and Black, David S., JD, Methods of Valuating Properties Without Compare, Appraisal Journal , (January 2000) p. 2 . 8. 9. 10. 11. 12.
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13. 14. 15.