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derived, not merely from salaries, wages, or compensation for personal service, but also from business, trade, commerce, or sales or dealings in property, or the transaction of any lawful business carried on for gain or profit. This plainly includes such gains and profits derived from or through a partnership.

Section B also states what deductions shall be made from the gross income of a taxable person in order to ascertain the net income for the purpose of levying the normal tax. Among these deductions is the amount received as dividends upon the stock or from the net earnings of any corporation, joint-stock company, association, or insurance company which is taxable upon its net income.

Section G provides for the normal tax upon the entire net income of corporations. It expressly excludes partnerships therefrom. This net income of corporations is subject only to the normal tax, such as is levied on the income of any natural taxable person, and not to the additional tax provided for by subdivision 2 of section A. This income from corporations received by a natural taxable person is exempt only from the normal income tax, and not from such additional tax.

Taking these provisions as a whole, the paragraph of section D relating to partnerships above quoted must be considered and construed in the light of the general scheme thus outlined. No provision is anywhere made requiring a return to be made by a partnership upon its income. This is true notwithstanding section D requires copartnerships, having the control, receipt, disposal, or payment of fixed income of another person subject to tax, to make a return in behalf of that person and to deduct the same. This provision deals with the fiduciary relationship of guardians, trustees, executors, and so forth, having the possession and control of other persons' property; but, as regards an ordinary partnership and its ordinary business, the statement is true that no return is required to be made under the federal income tax law of 1913 by a partnership.

Partnerships are expressly excluded from section G, requiring returns and payment of the normal tax by corporations. If congress had intended that partnerships, as such, should be taxable upon their net income, the logical place to have so provided would have been in section G, and to have excluded from the net income of a natural taxable person, subject to the normal tax, that part of his income derived from a partnership just as is provided with respect to his income derived from a corporation.

This law, therefore, ignores for taxing purposes the existence of a partnership. The law is so framed as to deal with the gains and profits of a partnership as if they were the gains and profits of the individual partner. The paragraph above quoted so provides. The law looks through the fiction of a partnership and treats its profits and its earnings as those of the individual taxpayer. Unlike a corporation, a partnership has no legal existence aside from the members who compose it. The congress, consequently, it would seem, ignored, for taxing purposes, a partnership's existence, and placed the individual partner's share in its gains and profits on the same footing as if his income had been received directly by him without the intervention of a partnership name.

It follows from these considerations that legally the defendant's share of the gains and profits of the Pickands, Mather & Co., derived from corporations taxable on their net incomes, is to be treated as if the same had been received by him directly from the taxpaying corporations.

The contrary contention is based on a literal reading of the words, "the share of the profits of a partnership to which any taxable partner would be entitled if the same were divided, whether divided or otherwise, shall be returned for taxation and tax paid." This sentence follows language plainly ignoring the existence of partnerships for taxing purposes. Section B had already provided what should be regarded as net income in

language sufficiently comprehensive to include the gains and profits from business carried on in a partnership name. The words just quoted evidently, apply only to the possibility that a partnership might not divide its gains and profits, but retain them in the firm name or business. It was to meet this possibility that these words were added, and not to provide an unequal and unique method of taxing a partner's gains and profits from a partnership.

The contention to the contrary is narrow and literal, even if not lacking in plausibility. It is a contention, however, contrary to the spirit and general policy of the act; it destroys uniformity and equality and should not be adopted unless required by the express language of the statute. In my opinion, the language of the statute does not so require; but, on the contrary, when the entire act is examined, it does give a right to the deduction.

Counsel for plaintiff invoke the legal principles that an exemption in a tax law must be clearly expressed and will not be implied; that power to tax will not be taken away unless the lawmaking power has done so in clear and unequivocal language, and that, inasmuch as uniformity and equality is difficult if not impossible of attainment in tax laws, the inequality which might result from the government's contention should not be permitted to control the language of the law. Numerous authorities illustrating these legal principles are cited. These principles are well settled, and I assume ample power in congress to have assessed defendant's income derived from a partnership in the manner contended for. It is my opinion, however, that congress has not done so.

Counsel for plaintiff call attention to the fact that the federal income tax law of September 8, 1916, now provides that members of partnerships shall be allowed credit for their proportionate share of partnership gains and profits derived from corporations taxable on their net income, and urge that this is a change of the law, and evidences a belief of the lawmaking body that the 1913 income tax law had provided differently. I do not agree with this contention. In my opinion, this provision was inserted in the 1916 act to put at rest the present controversy rather than to change the law, and is to be regarded only as a legislative recognition of the scope and intent of the prior law. The applicable authorities, in my opinion, are the following: Bailey v. Clark (21 Wall., 284); Johnson v. Southern Pacific Co. (196 U, S., 1); Wetmore v. Markoe (196 U. S., 68).

Judgment is rendered in favor of defendant. An exception may be noted on behalf of plaintiff.

JUNE 26, 1918.

Students' Department
EDITED BY SEYMOUR WALTON

(ASSISTED BY H. A. FINNEY)
AMERICAN INSTITUTE EXAMINATION

ACCOUNTING THEORY AND PRACTICE

PART I In regard to the following attempt to present the correct solutions to the questions asked in the examination held by the American Institute of Accountants in May, 1919, the reader is cautioned against accepting the solutions as official. They have not been seen by the examiners—still less endorsed by them. Problem 1:

A has agreed to sell to B the goodwill of the X. Y. Co. on the basis of three years' profits of the business to be determined by you on sound principles of accounting as accurately as possible from the following statement handed you by A. You are required to compute the value of the goodwill, but are not expected to take into account any considerations outside those presented by the statements. Credits: Sales (selling prices substantially uniform during period)

$638,400 $602,500 $564,000 Estimated value of construction

work performed and charged to property

110,000 77,600 154,000 Appreciation of real estate upon revaluation by experts

80,000 Profit on sale of Bethlehem Steel Co. stock

85,000 Inventory at end of period: Production material at cost

72,000 103,100 106,600 Finished goods at selling prices 76,500 114,000 150,000

$896,900 $977,200 $1,059,600

1st year

2nd year

3rd year

$233,000

$220,300

Debits :

Production materials purchased
Production labor
Production expense (including

50,850

$252,400

61,400

60,900

depreciation)
Selling expenses
Interest
Cost of construction work
Inventory at beginning of period:

Production material at cost
Finished goods at selling prices

66,750
52,500
96,000
74,600

69,300
55,650
94,000
49,000

70,300 62,800 98,500 86,000

51,400
54,900

72,000
76,500

103,100
114,000

$680,000

$730,250

$815,900

$216,900

$245,950

$243,700

Balance, being profit claimed by A

Solution, Problem 1:

Since the goodwill is to be computed on the basis of sound accounting principles, it is necessary to eliminate from the stated profits any unrealized or extraneous profits which have been included in the profits claimed by A.

Doubtless the most apparent error is the inclusion of an unrealized profit on construction work during each of the three years. The amount of profits improperly claimed is shown in the following schedule.

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The profits must also be reduced by the amount of the unrealized appreciation of real estate which has been credited to income. The authority of experts may be sufficient evidence to assure the company that the real estate is worth $80,000 more than it has been carried on the books for, but it is by no means sufficient evidence to warrant a credit to income; and even if the real estate had sold at an increase of $80,000, this profit, realized in such a case, would not be a proper profit to include in the computation of the goodwill. Goodwill should be based on realized operating profit. For this reason the profit on the sale of Bethlehem Steel Company stock, $85,000, is also excluded from the profits upon which the goodwill is based. This $85,000 was realized, but it was by transactions extraneous to regular operations.

The following schedule shows the total unrealized and extraneous profits which are excluded from the goodwill computation.

SCHEDULE 2 SUMMARY OF UNREALIZED AND EXTRANEOUS PROFITS, EXCLUDED

FROM GOODWILL COMPUTATION

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After deducting these excluded profits from the total profits claimed by A, the apparent profits from operations would be the amount shown in the following schedule.

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These apparent operating profits, as claimed by A, are erroneous because of the valuation of the finished goods inventories at selling prices. It is imperative, therefore, to reduce these inventories to their cost value. In order to make this reduction, it will be necessary to ascertain the cost of production during each of the three years.

SCHEDULE 4 STATEMENT OF PRODUCTION Cost Production material: Inventory-beginning

51,400.00 72,000.00 103,100.00 Purchases

233,000.00 252,400.00 220,300.00

1st year

2nd year

3rd year

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Having computed the cost of the goods manufactured during the period, the next step is to compute the selling price of the goods manufactured during the period. Working on the theory that the first goods received in stock are the first goods sold, it may be assumed that the inventory of finished goods at the beginning of each year is sold during the year. The remainder of the sales would, therefore, necessarily be made from goods manufactured during the year. Also the inventory at the end of the year would necessarily consist of goods made during the year. The selling price of the goods manufactured during the period is, therefore, computed as shown in the following schedule.

SCHEDULE 5 STATEMENT SHOWING SELLING PRICE OF GOODS MANUFACTURED Each YEAR

1st year

2nd year

3rd year

638,400.00

602,500.00

564,000.00

Sales
Deduct inventory of finished goods

at beginning of year: goods sold during the year but manufactured during preceding year (selling price)

54,900.00

76,500.00 114,000.00

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