by the others through a lower combined tax. If no losses are expected but the income of one or more of the related companies will sometimes fall below $25,000, separate returns may be advisable because of the $2,000 exemption. If a consolidated return is filed, each subsidiary corporation is required also to file Form 1122 (Art. 632). Only one specific exemption of $2,000 is permitted (Art. 636). The consolidated questionnaire, Form 819, should be obtained from the collector and submitted with the first consolidated return if this has not already been done.

In consolidating the income accounts, the usual accounting requirements should be observed: namely, that intercompany sales and purchases and the intercompany profits in the opening and closing inventories be eliminated. Depreciation should be based only on actual cost to outsiders (or March 1, 1913, value) and intercompany dividends or charges should be balanced off against each other. Consolidated invested capital follows the principles of the consolidated balance sheet and is discussed in Articles 864-8.

Each affiliated corporation included in a consolidated return is entitled to the same benefits under the exemption provisions of the Liberty bond acts to which it would be entitled if not affiliated (T. B. R. 7). A corporation turned over a branch of its business to a new company not incorporated, the new company simply using the assets without paying for them; it was held that the income of both should be reported as income of the corporation in one return (O. D. 467). Corporations, affiliated within the meaning of the law and filing consolidated returns, are not permitted to file consolidated returns of information at the source (O. D. 469). Attention is called to the rule applicable to consolidations appearing in Article 633; this rule modifies the information called for on old Form 1120 (Mim. 2930).

The retroactive provision in the 1921 act, permitting consolidated returns for 1917, requires that substantially all of the stock be owned by the parent company. If only 51% was owned a part of the year, the requirement of the law was not met even though a substantial amount was in the possession of the parent company for the balance of the year. But where a subsidiary

was controlled through the ownership of all the stock, directly or through another subsidiary, affiliation was present (A. R. R. 1232). Under the 1917 act a corporation could not affiliate with a foreign partnership but income so received was taxable to the corporation (O. D. 230).

A consolidation was disallowed to a corporation that rented land, its only asset, from a subsidiary whose stock was owned by them in excess of 99%, because the stock was held in an irrevocable trust which retained the voting power (A. R. R. 641). If the Bureau was unable to require a consolidation it was unable to grant one (T. B. M. 32). Where the wife's rights of ownership are recognized, husband's and wife's corporate holdings should not be taken as one (A. R. R. 942). One corporation owned the controlling interest in two other corporations but the directing officer (vice-president and general manager) in each subsidiary was of the minority group of stockholders and had no interest in any of the other corporations. The corporations could not file a consolidated return as affiliated corporations inasmuch as the parent company had not, in effect, exercised any control over the subsidiaries, it being presumed that the minority officer in each case was serving primarily his own interest (A. R. R. 378). A partnership owning all the stock of a corporation cannot file a consolidated return and thus reduce its income by the losses of the corporation (O. D. 795). A corporation in the hands of a receiver could not be included in an affiliation (A. R. R. 818). Where 6% and 25% of the stock of two corporations was owned by minority stockholders, a consolidated return of affiliated corporations was not permitted, as substantially all the stock was not owned and controlled by the same interests (T. B. R. 52). Two stockholders owned the entire stock of two corporations, but their respective shares in both corporations were not alike; hence a consolidated return was not permitted (T. B. M. 32). A stock control of 69.04% in the year 1918, without intercompany operating transactions or artificial intercorporate relationship, was insufficient to authorize a consolidated return for that year (A. R. R. 448). Without the necessary stock ownership, close intercompany commercial and financial relationship did not entitle certain businesses to file a consolidated return (A. R. R. 123). Intercompany sales alone do not constitute conclusive evidence of "closely related businesses" (A. R. M. 43). More than 50% of the sales of one corporation were made to another corporation and all of its capital stock was owned by the second corporation. Inasmuch as the sales were made at current market price and no other intercompany relationships

existed, separate returns were required (A. R. R. 624). Two corporations were not allowed to consolidate unless there was a sufficient stock ownership, even if one controlled and operated the property of the other and paid the taxes for both companies (0. D. 734). The shifting of income or profits from one corporation to another is not the determining factor under the Revenue Act of 1918 in deciding whether or not the returns of such corporations should be consolidated; the test is that substantially all of the stock is mutually owned or controlled (A. R. R. 2958). The filing of a consolidated return for 1922 by two affiliated corporations constituted an exercise of the election permitted by Section 240 (a) and separate amended returns for 1922 cannot be filed (I. T. 1777). But when a corporation secured ownership and control of another corporation for a negligible part of 1922 and separate returns were filed, this did not constitute an election denying the right to file a consolidated return for 1923 (I. T. 1783).

XXX

REVIEW OF RETURNS-CLAIMS-PENALTIES

Audit of returns. Hearings before field divisions, income tax unit, and Committee on Appeals and Review. Claims for abatement, credit, and refund. Nature of appeals and briefs. Penalties.

RETURNS are subjected to a preliminary examination by the collector and if found to be incorrect, the additional tax due is assessed, no penalties being attached unless the deficiency arises from fraud, negligence or "intentional disregard"; interest, however, may be charged at 6% per annum.' If the result is in favor of the taxpayer, the amount is credited to subsequent instalments, or if in excess thereof, the excess is refunded to the taxpayer. Assessments under the 1921 act must be made within four years after the return was filed (Sec. 250(d)); under prior acts, five years.

The Department is given the right under the law (Sec. 1308, Art. 1711) to examine the taxpayer's books and other records, but it is to be noted that the examination will be useless unless made before the statute of limitations just mentioned begins to operate. More than a million tax returns are handled yearly by the Department and a satisfactory audit of even 50% of them is virtually impossible. By the middle of 1923 practically no returns for 1921 and 1922 had been reviewed, and nearly 30,000 returns for 1917 were remaining uncompleted. By special provision of an act of March 4, 1923, amending Section 252, six years were permitted the Department from the due date of the return (that is, until April 1, 1924) to complete the audit of 1917 returns against which waivers had been obtained. Waivers refer to formal documents which the Department has frequently asked taxpayers to sign and which extend the 1 See "Penalties," on page 297.

period, limited by the statute, for the examination of returns. The case of a taxpayer is not prejudiced should he refuse to sign a waiver, but on the other hand he has usually much to gain by signing it.

If the result of a field audit covering returns from 1917 to 1921, inclusive, has been the reduction of invested capital because of insufficient depreciation taken in past years, a refund will be allowed (in spite of the five-year limitation otherwise applicable) in connection with all prior tax returns (Art. 1037; Sec. 252).

Thirty-five audit divisions, with headquarters in the principal cities of the country, are now in active charge of the field work of checking returns1. Each division has its staff of examiners or auditors. An examination of a taxpayer's books-now usually covering a period of two or three years at a time is followed by the issuance of a report thereon, a copy of which is immediately given the taxpayer. The taxpayer is allowed twenty days in which to make protest if he disagrees with the findings and an extension will be granted if good reasons are given. During that period he should collect such additional facts as may be necessary and present them, orally or in written form (duplicate), to the internal revenue agent in charge at the division office. The additional facts will be examined carefully, perhaps another audit will be made, and a revised report will be issued, if necessary, and a copy forwarded to the taxpayer. Again the taxpayer has a twenty-day period in which to file his exceptions. If he takes no exception to either the first or second report he should so notify the revenue agent in charge who will thereupon transmit the report to Washington (I. T. 1815). This procedure, only recently put in force, will simplify, and already has immensely simplified, the taxpayer's problems. Frequently he disagrees with the field examiner on questions of fact which are hard to prove after the report has reached Washington. If he cannot agree with the findings of the local

1 See page 22.