## Facts

- Prairie Oil & Gas Co. and Ohio Oil Co. operated both petroleum production activities and interstate pipeline transportation through company-owned lines.
- After federal regulation treated the pipeline transportation business as common-carrier activity subject to federal oversight, each company sought to separate pipeline operations from the rest of its business.
- Stockholders caused new pipeline corporations (including Prairie Pipe Line Co.) to be formed, and the original company transferred its pipeline assets to the new company.
- The new company issued all of its capital stock in exchange for the transferred pipeline assets, and that stock was distributed pro rata to the original company’s stockholders, either directly or through the original corporation.
- The original company had sufficient accumulated surplus so the transaction left its stated capital unimpaired and required no reduction of outstanding shares.
- John D. Rockefeller received Prairie Pipe Line stock pro rata to his Prairie Oil holdings; the government assessed federal income tax on the distribution as a taxable dividend under the Income Tax Act of 1913.
- In a companion case, executors of an estate paid the tax under protest and sued to recover it; both matters were upheld in the district court and reviewed together.

## Issues

1. Whether a pro rata distribution of stock of a newly created pipeline corporation, made as part of a reorganization and funded from the original corporation’s surplus, is a “dividend” and taxable “income” under the Income Tax Act of October 3, 1913, and the Sixteenth Amendment.
2. Whether the distribution is taxable to individual shareholders even if their aggregate proportional interest in the combined enterprise is arguably unchanged.

## Decision

- The Supreme Court affirmed the judgments sustaining the assessments.
- The Court held that the shares distributed to stockholders were a “dividend” within the 1913 Act and “income” within the Sixteenth Amendment.
- The Court treated the distribution as a taxable gain to each shareholder because it transferred to the shareholder separate, exchangeable property representing a partial realization of corporate surplus.

## Legal Principles

- A pro rata distribution of stock of a newly formed corporation, where the original corporation transfers assets and uses accumulated surplus so that capital remains unimpaired, may constitute a taxable dividend rather than a non-taxable capital adjustment.
- For income-tax purposes, it is sufficient that the shareholder receives “actual, exchangeable assets” for individual use, converting an undivided, contingent interest in corporate surplus into separately owned property.
- The tax result does not turn on whether the new shares are issued directly to shareholders or first to the original corporation and then distributed; substance controls over transactional form in determining whether corporate profits have been distributed.

## Conclusion

The Court upheld taxation of reorganization-related spin-off shares distributed pro rata from corporate surplus, reasoning that each shareholder realized income when corporate surplus was segregated and transferred to the shareholder as separately alienable stock.


Rockefeller v. United States, 257 U.S. 176 (1921)