or may not result in a saving of taxes. Based on market values. losses are taken, but profits are not anticipated.

The Treasury has issued rulings summarizing the rates of exchange as of December 31, for each year from 1916 to 1923 inclusive. These rulings will be found in the bulletins as follows:

Quotations relating to certain countries appear in other rulings

(in addition to those quoted above).

Income from Government Contracts.

In the 1918 and 1921 laws a distinction was drawn between income arising from government contracts and that from other sources. The purpose of the differentiation was to tax government contract income at the high tax rates in force for the year 1918 even if such income arose in a subsequent year up to and including 1921.

As corporate incomes are now subject only to a flat rate of 121⁄2 per cent, there is no longer any necessity for distinguishing government contract income from any other income. Thus the 1924 law has no provision corresponding to section 2 (11) of the 1921 law.56

[Former Procedure] The law, regulations, rulings and comments on the 1918 and 1921 laws in respect to government contract income will be found in Income Tax Procedure, 1924, page 513 et seq.

The subject of inventories has assumed such great importance in income tax procedure that a proper discussion of the subject justifies a special chapter.

When a concern maintains a stock of any kind of property which is periodically renewed as it becomes exhausted, the proper procedure in determining profit or loss is to inventory the stock. Regarding inventories the law provides:

LAW. Section 205. Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

The 1918 law for the first time gave the Commissioner specific authority to require inventories, although they have as a matter of

fact been used under regulations of the Treasury ever since the passage of the 1909 law.1

REGULATION. In order to reflect the net income correctly, inventories at the beginning and end of each year are necessary in every case in which the production, purchase, or sale of merchandise is an incomeproducing factor. . . (Art. 1611.)

Inventory must be taken as of one fixed date for entire business.

RULING. Taxpayers will not be permitted to adopt one period for inventorying and closing their books applicable to one part of their business and a different period applicable to another part thereof. (C. B. 1, page 62; O. D. 289.)

Taxpayers are of course permitted to adjust book inventories by physical count throughout the year, so as to avoid any considerable adjustments at the end of the year.

Inventories in the case of amended returns.-If inventories have been taken on any basis other than that of "cost" or "cost or market, whichever is lower," amended returns may be filed and either one of the two bases mentioned above may be used.2 In a specific case in which revenue agents at first refused to recognize a change from "cost" basis to "cost or market, whichever is lower," they assented when an analysis of the method originally used by the taxpayer showed that the basis was not strictly one of "cost."

Who may use inventories.-Specific permission to use inventories has been given in the following cases:

DEALERS IN FOREIGN EXCHANGE.

RULING. A dealer in foreign exchange-that is, one who regularly engages in the purchase and resale to customers of foreign money (C. B. 4, page 61; O. D. 834.)

When foreign exchange is purchased incident to a business such as that of an importer, there would seem to be no good reason why

1

[Former Procedure] Even under the regulations issued to control the procedure under the 1913 law and in spite of the doubtful authority in the law for the use of the accrual method, the Treasury specified that inventories should be used in certain cases. Art. 161, Reg. 33, January 5, 1914. For 1917, see Reg. 33, 1918, Art. 120 For a general discussion of the Treasury's position regarding inventories under all laws prior to 1921, see former editions of this book; also Inventories by H. B. Fernald, Proceedings, American Mining Congress, 1923.

"Market" may be used by dealers in securities (Art. 1615). See also C. B. 5, page 63; O. D. 1132.

4

See also C. B. II-2, page 32; A. R. R. 3131.

the amount held at the end of the year should not be inventoried. It is to such importer an asset used in trade, and should therefore be subject to the usual rules for valuing trade assets.

DEALERS IN SECOND-HAND AUTOMOBILES.-Used automobiles ostensibly taken in trade at a value higher than probable sales value may immediately be valued at "bona fide selling prices, less selling cost." 4

FARMERS, COTTON PLANTERS, ETC.-If they so desire, farmers may compute their income by the use of inventories, but such procedure is not obligatory.5 Cotton planters are considered to come within the definition of farmers stated in article 38, even though the planters own cotton-gins and purchase their tenants' cropshares.R

Real estate dealers not permitted to use inventories.—

RULING. A taxpayer, engaged in the real estate business, is not permitted to inventory real estate which is held for sale for the purpose of calculating net income subject to Federal income tax. (C. B. 4, page 47; O. D. 848.)"

Oyster culture--inventories not permitted.-There are some businesses, it seems, in which the use of inventories does not reflect true net income.

RULING. The net income of a person engaged in the business of propagation and culture of oysters can not be properly computed upon the basis of inventories. . . . . (C. B. 3, page 80; O. D. 684.)

Estimated inventories are not permitted.

RULING. A taxpayer who for many years has elected to take inventory only every two years, and used an estimated inventory in the return for the intermediate year, making any necessary adjustments in the return for the following year when an actual inventory was taken, may not apportion his total earnings for the two years 1917 and 1918 equally between such years for income tax purposes. (C. B. 1, page 62; 0. D. 133.)

It would seem, however, that if an estimated inventory which can be verified by the "gross profit" test has been used in former

C. B. II-2, page 35; A. R. R. 3549; and C. B. 4, page 49; O. D. 888. * Art. 1586.

Letter to Hon. B. G. Humphreys, signed by Commissioner D. H. Blair. dated August 30, 1923.

See Chapter XXVI with reference to the effect of capital gains provisions arising from denial of inventory privilege.

years, and that there is no material fluctuation in the rate of gross profit to the date when an actual physical inventory is taken, such estimate must be acceptable.

REGULATION.

What Inventory Includes

The inventory should include raw materials and supplies on hand that have been acquired for sale, consumption, or use in productive processes, together with all finished or partly finished goods. .. .. (Art. 1611.)

The regulation refers to goods "on hand" which is synonymous with a physical inventory. Physical inventories or their equivalent are absolutely necessary in every concern handling materials or goods; but recognized accounting principles do not require that physical inventory be taken of everything on hand on a specific date. If a book inventory is trustworthy and the entire stock is actually verified. in whole or in part at various times during the year, taxpayers need have no hesitancy in stating that article 1611 has been complied with.

Advances to foreign corporation excluded.-The Treasury has ruled that advances to a foreign corporation by an American firm may not be inventoried, even though a considerable decline in the exchange rate has occurred.8

Any conservative balance sheet would show such assets “inventoried" at the current rate of exchange. Strictly speaking, the word "inventory" does not include accounts receivable, but a fall in exchange rates is equivalent to a fall in the market value of goods. The accrued loss should be claimed. Goods of a certain value have been exchanged for other property, viz., a chose in action. When valued at the equivalent of cash the chose in action is worth less than the sales value of the goods. True net income cannot be determined unless the resulting loss is taken into account.

Bailments-when included in inventory.-In some branches. of business it is customary to send material to other concerns for some form of processing, for instance, bleaching or dyeing. At the date of the inventory such items are included in the inventory if they are to be returned in kind; but some firms have varying arrangements for the return of the "products of the property," such as flour for wheat, refined copper for ore, etc. In such cases the Treasury

See also C. B. II-2, page 32; A. R. R. 3131, holding that cash balances in foreign banks and advances to foreign merchants cannot be inventoried.