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deduction on this account shall be allowed. The same rule will apply in the case of timber or timber lands purchased subsequent to March 1, 1913, the only difference being that actual cost, that is the gross purchase price, shall, in making the computation, be substituted for en bloc price or value as of that date. If the entire market price or value of both timber and lands, as of March 1, 1913, or the entire cost, if acquired subsequent to that date, is extinguished through a deduction from gross income for timber used, or through a per unit charge to cost of manufacturing lumber, then the entire amount realized from the logged-off lands or for other salvage, will be returned as income of the year in which such lands are sold or disposed of. If the timber or timber lands are sold en bloc, the gain or loss will be ascertained on the basis of the difference between the fair market price or cost and the selling price, accordingly as the property was acquired prior or subsequent to March 1, 1913. The fair market price or value of timber or timber lands, as of March 1, 1913, is the price at which the property in its then condition and with the circumstances then surrounding it, could have been sold, for cash or its equivalent. This value must not be speculative, but must be determined without taking into account any prospective profits that may result from the manufacture of the timber into lumber. It must be, as the law contemplates, a fair market value, and, once determined, must be set up on the books, and, as the measure of a stumpage deduction for income tax purposes must remain constant and cannot be increased. The value so set up as of March 1, 1913, will be subject to the approval of the Commissioner of Internal Revenue. You are also informed that this office is not prepared to express an opinion at the present time as to what stumpage value would constitute a fair value of short leaf North Carolina pine as of March 1, 1913, and in regard to your further request you are informed that the ruling contained in the above regulation will refer equally as well to the years 1913, 1914 and 1915, with the exception that the cost of the timber shall be the governing basis instead of its value as of March 1, 1913."

DEDUCTIONS ALLOWED CORPORATIONS

"All the ordinary and necessary expenses paid within the

year in the maintenance and operation of its business and properties" are deductible from gross income of Expenses. corporations.

All losses actually sustained and charged off within the year, not compensated for by insurance or other- Losses Dewise, are deductible items.

ductible.

The deduction for losses must be losses actually sustained during the year and not compensated by insurance or otherwise. It must be based upon the difference between the cost value and salvage value of property or assets, including in the latter value such amount, if any, as has, in the current or previous years, been set aside and deducted from gross income by way of depreciation. (Art. 124, Reg. 33.)

Deductions for losses should be confined to losses actually sustained and charged off during the year, and not compensated by insurance or otherwise. (Art. 158, Reg. 33.)

Profit or

Losses not compensated by insurance must be Loss Dededucted from the return of net income for the ductible Only in year in which the loss was sustained. This ruling Year Sushas been upheld by the courts and is strictly enforced. tained. For the purpose of computing the profit or loss from the sale of property of a corporation, acquired Loss on prior to the incidence of the law, March 1, 1913, such properties shall be valued as of that time Before at the fair market price thereof. This applies to March 1, both real and personal property.

Property
Acquired

1913.

A reasonable allowance for the exhaustion, wear and tear of physical properties of a corporation arising out of its use or employment in the business or trade is deductible Depreciain the year that such depreciation is sustained. tion DeThe amount deducted must be actually charged off upon the books of the corporation. (See "Depreciation," page 175.)

ductible.

Depletion

(This deduction is considered in Chapter VI, on of Oil and Depreciation, page 181.)

Gas Wells.

Under the Act of September 8, 1916, the provision of the Income Tax Act of 1913, limiting the charge for depletion of

mines to "5 per cent. of the gross value at the mine Depletion of the output for the year" has been repealed, and of Mines. there has been substituted the provision that a reasonable allowance for depletion thereof will be permitted, "not to exceed the market value in the mine of the product thereof, which has been mined and sold during the year for which the return and computation are made" under rules and regulations to be prescribed by the Secretary of the Treasury.

Inasmuch as the operating conditions of mines are so materially different, the rate of depletion should be computed on a basis that will provide for the particular requirements of each case.

. In Grand Rapids & Indiana Railway Co. v. Doyle, Collector Mainten(United States District Court for the Western ance De- District of Michigan, Southern Division 1) maintenfined. ance was defined as follows:

"Maintenance means the unkeep or preserving of the condition of the property to be operated and does not mean additions to the equipment, additions to the property, or improvements of former condition of the road."

Improve

ments.

As a general proposition the cost of renewals in like kind and quality may be charged off as expense. Where the reRenewals. newal, however, is also an improvement, as, for example, replacing a wooden bridge with a steel bridge, wooden doors with steel doors, a motor of twenty horse-power by one of fifty horse-power, the excess cost would not be allowable as a deduction. (T. D. 2210.) The income tax law does not provide specifically, with respect to corporations, for the deduction of bad debts or uncollectible accounts. The officers of the Treasury Department, however, having the administration of the law in charge, have ruled that the same may be deducted as losses. (See also page 213.)

Bad Debts.

To provide for doubtful and anticipated bad debts, by establishing a reserve for that purpose, has always

Reserves

for Bad been considered good accounting practice, but such Debts. reserve is not deductible from an income tax return. Accounts receivable, to be deductible from income,

1T. D. 2210.

must actually have been ascertained to be worthless. Besides, an account, to be deductible, must be actually written off in the period for which it is deducted.

Insurance

Amounts added to reserve funds of insurance Reserve companies, as required by law, are deductible from Coma return of net income.

panies.

Reserves set aside for contingencies, or so-called "secret reserves" are not deductible from returns of an- Contingent nual net income. Charging capital expenditures and Secret Reserves. to operating expenses is specifically prohibited.

Items held in suspense, pending an event, are Suspense not deductible from income for income tax purposes. Items. Amounts set aside out of profits, or reinvested, for the purpose of redeeming outstanding bonds payable, are Sinking not deductible from taxable income. The redemp- Fund Retion of bonds is a capital expenditure.

serves.

Discounts on sales of commodities dealt in are only deductible to the amount actually allowed to customers. Reserve for A reserve for cash discounts, the establishment of Discounts which is approved by modern accounting, being on Sales. anticipatory and not actual, is not deductible from income. A corporation is allowed as a deduction interest paid within the year on such an amount of indebtedness as Interest does not exceed the sum of: Deductible. (a) The entire amount of the paid-up capital stock outstanding at the close of the year, or if no capital stock, the entire amount of capital employed in the business at the close of the year, and

(b) One-half of its interest-bearing indebtedness then out

standing.

This subject is more fully dealt with on page 202.

Purchase

Under the Income Tax Law, as amended by the Interest War Revenue Act, interest paid within the year on Incurred in indebtedness incurred for the purchase of Liberty of Liberty 4 per cent. bonds may be deducted in computing 4's. net income subject to income surtaxes and excess-profits taxes. In case of corporations this is subject to the limitations imposed by the income tax law on the amount of indebtedness, interest on which may be deducted. (T. D. 2541.)

ness Se

etc.

The interest paid during the year on indebtedness wholly secured by collateral, the subject of sale in the ordinary business Interest on of a corporation, joint-stock company or associaIndebted- tion, is deductible as an expense of doing business. Collateral, which may be the subject of sale in the cured by Collateral, ordinary business of a company, refers to commodities in which the company deals. Real estate, in this sense, could only be the subject of sale in the case of a corporation engaged in the buying and selling of real estate. This applies to both tangible and intangible property secured by collateral, but limits the amount of indebtedness on which the interest may be computed to the actual value of such property collateral.

In the case of Anderson v. Forty-two Broadway Co. (209 Fed. 991 and 213 Fed. 777, reversed by U. S. Sup. Ct., Oct., 1915) (T. D. 2261), it was held under the Corporation Excise Tax, that a real estate company owning and operating an office building, under mortgage, could not deduct the interest paid on such mortgage as a general expense, under item 4 (a) (Form 1031) but only in item 6 (a), which made it subject to the limitation of law as to deductibility of interest. For limitation of deductible interest under present law see page 204.

Interest on any form or class of capital stock is not deductible from an income tax return. The fact that preInterest on Preferred ferred stock is "guaranteed" or cumulative as to Stock. interest, does not make it deductible.

Interest paid on outstanding bonds payable of a corporation Interest on is a deductible item. Where bonds are held by Bonds of Согрога- trustees, however, for the benefit of the issuing corporation, interest paid thereon is not deductible.

tion.

In the case of a corporation selling its own bonds at a discount, the amount of the discount should be prorated Amortiza- over the life of the bonds and the proportionate tion of Dis- part of such discount applicable to each year during count on the life of the bonds, constitutes an allowable deducBonds. tion from the gross income of such year. The deduction from gross income in the case of twenty year bonds, would be one-twentieth of the aggregate amount of the discount on the bonds sold. (T. D. 2137.)

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