In Bates Manufacturing Co. v. United States, the Supreme Court ruled on a dispute regarding federal taxation of corporate dividends paid out from capital surplus rather than profit earnings. The case involved Bates Manufacturing Company, which had distributed dividends to its shareholders not from current or accumulated profits but instead from a reevaluation surplus created by an increase in the value of its assets during World War I. When these dividends were taxed as income by the U.S government under Revenue Acts of 1921 and 1924, Bates challenged this decision arguing that such distributions should be exempted as they did not constitute "income" within the meaning of Sixteenth Amendment. The Supreme Court disagreed with Bates' argument and upheld lower court decisions stating that Congress has broad power to define taxable income under Sixteenth Amendment and it can include dividend payments made out of capital surplus within this definition if it so chooses through legislation like Revenue Acts in question here. Therefore, even though these dividend payments might have been sourced from increased asset values (capital gains) rather than company's operational profits per se; they could still be considered part of shareholder's taxable "income".

In the dissenting opinion for Bates Manufacturing Co. v. United States, it was argued that the majority's decision to uphold a tax on cotton processing was incorrect because it violated principles of federalism and exceeded Congress' power under the Commerce Clause. The dissenters believed that this tax interfered with state sovereignty by imposing a direct burden on an industry primarily regulated by states, namely agriculture. They also contended that while Congress has broad powers to regulate interstate commerce, these powers do not extend to directly taxing local activities such as cotton processing which are only indirectly related to interstate commerce. Furthermore, they expressed concern about potential abuses of power if Congress were allowed to use its taxation authority in this manner.