The radical changes expected in business conditions as a result of the cessation of the war made it seem imperative that losses arising from readjustments of inventories, which might occur within a few months thereafter, should be spread over a longer period of time. Similar conditions existed in the case of losses arising from sales or depreciation of plant and equipment acquired for war purposes. To meet these difficulties the 1918 law provided certain socalled relief measures designed to assist in the re-establishment of normal conditions.2

1 [Former Procedure] Provision was made in the 1918 law [sections 214 (12-a) and 234 (14-a)] whereby losses resulting from a subsequent decline of a material amount in the value of the 1918 inventory, might be deducted from the net income of that taxable year and the tax be recomputed. An allowance for rebates was also permitted. A full discussion of this subject will be found in Income Tax Procedure, 1921, page 787 et seq. As a condition to the allowance of a claim under this provision, the Treasury illegally requires that the disposition of the entire inventory at the close of the 1918 taxable year be shown and that a net loss on the inventory must have been incurred. (C. B. 5, page 169; A. R. R. 554.)

Člaims for abatement covering inventory losses under 1918 law carry interest at I per cent per month.

For rulings dealing with rebates, see:

C. B. 1, page 155; A. R. M. 4.

C. B. 5, page 162; A. R. R. 590.

66

167; A. R. M. 136
130; O. D. 1067.

Ï-1, page 126; A. R. R. 921.

As to the deductibility of rebates under 1924 law, see page 922 et seq. 2 Referring to these provisions Senator Simmons said:

"In addition to the relief amendments placed in the income-tax title, but affecting profits taxes as well as income taxes, amendments relating to amortization and obsolescence, shrinkage in inventories, and so forth, the Senate added a general relief clause investing more or less discretion in the Commissioner of

[Ch. 39

In view of the obvious fairness of such legislation, some method of applying losses to a succeeding period will probably continue as a permanent feature of our income tax laws. Inventory values fluctuate to such an extent that any attempt to go back to the old practice of not permitting losses to be carried forward for a reasonable time would meet with great opposition.

The following provision of the 1924 law permits the application of the net loss of one year against the income of one or two succeeding years 3:

3

Internal Revenue and the Advisory Tax Board for relief in cases clearly establishing injustice, inequality or discrimination. The House conferees accepted these provisions of the Senate." (Congressional Record, Vol. 57, page 3134.) [Former Procedure] There are two principal points of difference between section 206 (b) of the 1924 law and the similar provision of the 1918 law. 1. The 1918 law permitted the application of the loss first against income of the preceding taxable year (involving a recomputation of the preceding year's tax and a refund of that previously paid) and the application against the following year's income of any excess of loss over income of the preceding year, whereas the 1924 law (and also the 1921 law) permits the application of a net loss of one taxable year only against income of one or two succeeding

years.

2. The net loss provision of the 1921 and 1924 laws is continuing in its character, whereas that in the 1918 law related only to net losses sustained in the years ended October 31, November 30 or December 31, 1919, respectively.

In ruling C. B. I-1, page 45; I. T. 1179, the Treasury held that "the term 'net loss' as used in section 204 of the Revenue Act of 1918 refers to a net loss attributable to the sale of capital assets as well as to operating losses." Later, the ruling was reversed in I-31-434; I. T. 1401. holds that that part of a net loss, resulting from the sale of capital assets by a The Treasury now corporation in 1919, cannot be deducted from net income for the taxable year 1918, unless such loss resulted from the sale of assets described in section 204 (a-2), which specifies: "plant, buildings, machinery or other facilities, constructed, installed or acquired . . . . on or after April 6, 1917, for the production of articles contributing to the prosecution of the present war." Notwithstanding the quotations in I. T. 1401 from Senator Penrose and Senator Lenroot, it is believed by some authorities that the phrase, "net losses resulting from . . . . the operation of any business regularly carried on by the taxpayer," includes any loss arising from the sale of capital assets used in connection with the business. The same authorities admit that any losses due to the sale of capital assets which have not been used in the business regularly carried on by the taxpayer are not deductible.

These authorities urge that clause (2) of section 204 was added because many concerns manufactured munitions which were not in their regular line of business and that if clause (2) had not been included, losses arising from the sale of such assets would have been excluded by paragraph 1.

The author believes that the later ruling (I. T. 1401) more nearly accords with the intention of the law than the former ruling. Nevertheless, if it can be shown in any case that a loss arising from the sale of capital assets is a part of the "operation" of a business, the loss should be claimed. The equities are clearly in favor of the taxpayer. The only question at issue is the technical interpretation of the statute.

See also C. B. I-2, page 37; A. R. M. 185: C. B. III-1, page 65; I. T. 1943.

Section 206.

LAW. (b) If, for any taxable year, it appears upon the production of evidence satisfactory to the Commissioner that any taxpayer has sustained a net loss, the amount thereof shall be allowed as a deduction in computing the net income of the taxpayer for the succeeding taxable year (hereinafter in this section called "second year"), and if such net loss is in excess of such net income (computed without such deduction), the amount of such excess shall be allowed as a deduction in computing the net income for the next succeeding taxable year (hereinafter in this section called "third year"); the deduction in all cases to be made under regulations prescribed by the Commissioner with the approval of the Secretary.

The 1924 law fails to correct the injustice worked by the 1921 law, in that it does not provide for the application of any part of the net loss arising in the taxable year 1920. Any doubt that the language of paragraph (b) of section 206 of the present law provides otherwise is removed by section 283 which provides that the effective date of Title II shall be as of January 1, 1924.

A change of form of organization will apparently prevent the benefits of the net loss sections of the 1918, 1921 and 1924 laws from becoming effective. The net loss of a decedent cannot be taken by his estate.5

But when a reorganization is effected under section 203 and the old entity is for tax purposes deemed to continue, it would seem that a net loss should be carried forward.

Definition of "net loss."

LAW. Section 206. (a) As used in this section the term "net loss" means the excess of the deductions allowed by section 214 or 234 over the gross income, with the following exceptions and limitations:

(1) Deductions otherwise allowed by law not attributable to the operation of a trade or business regularly carried on by the taxpayer shall be allowed only to the extent of the amount of the gross income not derived from such trade or business;

(2) In the case of a taxpayer other than a corporation, deductions for capital losses otherwise allowed by law shall be allowed only to the extent of the capital gains;

(3) The deduction for depletion shall not exceed the amount which would be allowable if computed without reference to discovery value; (4) The deduction provided for in paragraph (6) of subdivision (a) of section 234 of amounts received as dividends shall not be allowed; (5) There shall be included in computing gross income the amount of interest received free from tax under this title, decreased by the amount of interest paid or accrued [and losses sustained] which is not

'C. B. II-1, page 33; A. R. R. 1597. See also III-43-1838; I. T. 2094. C. B. II-1, page 33; I. T. 1562.

The phrase "and losses sustained" is meaningless and should be ignored. Its inclusion arose from an oversight in connection with the elimination of section 214 (c) from the Mellon draft.

allowed as a deduction by paragraph (2) of subdivision (a) of section 214 or by paragraph (2) of subdivision (a) of section 234.

Section 206 does not apply unless a "net loss" has been sustained. When a taxpayer's profit and loss account shows a loss, as that term is commonly used, further consideration is essential in order to determine the "net loss."

REGULATION. The term "net loss" as used in the statute applies to a net loss during the taxable year in a trade or business regularly carried on by the taxpayer. Included therein are losses from the sale or other disposition of real estate, machinery, and other capital assets used in the conduct of such trade or business. . . . . In order to be entitled to claim an allowance for a "net loss" the taxpayer must have suffered an actual net loss in a trade or business during the taxable year. The amount properly allowed may be neither the loss reflected by the return filed for the purpose of the income tax nor the net loss shown by the taxpayer's profit and loss account, but is to be computed according to the statute, as follows:

(1) In the case of an individual it is the amount by which the deductions allowed under section 214, excluding:

(a) the amount by which the deductions otherwise allowed by law but not attributable to the operation of a trade or business regularly carried on by the taxpayer exceed the amount of gross income not derived from such trade or business;

(b) the amount by which the deductions for capital losses otherwise allowed by law exceed the capital gains; and

(c) the amount by which the deduction for depletion exceeds the amount which would be allowable if computed without reference to discovery value.

exceeds the sum of the following:

(a) the gross income of the taxpayer for the taxable year as computed under section 213; and

(b) the amount by which the interest received free from taxation under Title II of this Act exceeds the amount of interest paid or accrued which is not allowed as a deduction by section 214 (a) (2);

(2) In the case of a corporation, it is the amount by which the deductions allowed under section 234, excluding:

(a) the amount by which the deduction for depletion exceeds the amount which would be allowable if computed without reference to discovery value; and

(b) the amount received as dividends and allowed as a deduction under section 234(a) (6),

exceeds the sum of the following:

(a) the gross income of the taxpayer for the taxable year as computed under section 233; and

(b) the amount by which the interest received free from tax under the provisions of Title II of the Act exceeds the amount of interest paid or accrued within the taxable year which is not allowed as a deduction by section 234 (a) (2).

In computing statutory net loss the following restrictions are to be noted:

(1) Interest received by the taxpayer on obligations or securities, the interest from which is exempted from taxation, must be included in the taxpayer's income but this amount is to be reduced by the amount of any interest paid by the taxpayer on money used to purchase or carry such obligations or securities;

(2) Where depletion is computed upon the basis of discovery value, in lieu of cost or value as of March 1, 1913, the deductions are reduced, in making the computations, by that portion of the depletion representing the excess of the discovery value over actual cost or value as of March 1, 1913. . . . . (Art. 1621.)

SOME DISTINCTIONS UNDER THE NEW LAW.--Subdivision (a) of section 206 of the new law defining a net loss corresponds to subdivision (a) of section 204 of the 1921 law, with some changes. It shows the deductions which are not allowable in computing the statutory net loss and also those additions which must be made to gross income before computing such a net loss. Paragraph (1) of this subdivision corresponds to clause (3) of section 204 (a) of the 1921 law. Mr. A. W. Gregg, special assistant to the Secretary of the Treasury, stated:

Since net losses are to be limited to those sustained in a trade or business, it is provided in the new law that not only losses but all other expenses not connected with a trade or business are allowable as deductions in computing the net loss only to the extent of the gross income not derived from the trade or business. The 1921 law placed this limitation only upon non-business losses; the new law extends the limitation to all non-business deductions.

The changes limiting capital losses are referred to in the following paragraph.

CAPITAL GAINS AND CAPITAL LOSSES AFFECT NET LOSS OF INDIVIDUALS. The new law [section 206, (c) and (d)] contains specific provisions which are applicable when capital net gains and losses occur in the second and third years. For full discussion see Chapter XXVI.

TAX-EXEMPT INTEREST CONSIDERED IN COMPUTING NET LOSS.The law provides in section 206 (a-5) that there must be added to gross income tax-exempt interest decreased by the amount of interest paid to purchase or carry securities, the income from which is wholly exempt from tax. For example: A has $100,000 of taxexempt interest, but paid $5,000 as interest to purchase or carry