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for the further reason that net losses are considered as the losses resulting from the operation of a trade or business, it is provided in the draft that in computing the net loss, capital losses shall be deductible only to the extent of the capital gains.

Method of carrying forward "net loss" when "capital net loss" is sustained in second year.—

LAW. Section 206. .... (c) (1) If in the second year the taxpayer (other than a corporation) sustained a capital net loss, the deduction allowed by subdivision (b) of this section shall first be applied as a deduction in computing the ordinary net income for such year. If the deduction is in excess of the ordinary net income (computed without such deduction) then the amount of such excess shall be allowed as a deduction in computing net income for the third year.

The way the limitation works may be seen from an example. Assume that a taxpayer in 1924 sustained a "net loss" of $10,000, that in 1925 he sustains a capital net loss of $15,000, and that his "ordinary net income" in 1925 is $6,000. The "net loss" of $10,000 is applied against the ordinary net income of $6,000 received in 1925 and the excess of such net loss ($4,000) may be carried forward and applied against the net income of 1926. It will be noted that the "capital net loss" does not enter into the computation.

Method of carrying forward "net loss" when "capital net gain" is derived in second year.

LAW. Section 206. .... (c) (2) If in the second year the taxpayer (other than a corporation) has a capital net gain, the deduction allowed by subdivision (b) of this section shall first be applied as a deduction in computing the ordinary net income for such year. If the deduction is in excess of the ordinary net income (computed without such deduction) the amount of such excess shall next be applied against the capital net gain for such year and if in excess of the capital net gain the amount of that excess shall be allowed as a deduction in computing net income for the third year.

The matter may be made clear by an example. Assume that a taxpayer in 1924 sustains a "net loss" of $10,000, that in 1925 he derives a "capital net gain" of $15,000, and that his "ordinary net income in 1925 is $8,000. The "net loss" of $10,000 is applied against the ordinary net income of $8,000, received in 1925 and the excess of such "net loss" ($2,000) is applied against the "capital net gain" of $15,000. The tax would be computed therefore on a "capital net gain" of $13,000. If the "net loss" sustained in 1924 exceeded the sum of the "capital net gain" and the "ordinary net income" derived

in 1925, then the excess of such "net loss" would be carried forward

to the succeeding year.

Net loss carried forward when there is capital net gain or capital net loss in third year.—

LAW. Section 206. (d) If any portion of a net loss is allowed as a deduction in computing net income for the third year, under the provisions of either subdivision (b) or (c), and the taxpayer (other than a corporation) has in such year a capital net gain or a capital net loss, then the method of allowing such deduction in such third year shall be the same as provided in subdivision (c). "

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The foregoing section means that the principles governing the method of carrying forward the "net loss" to the first succeeding year will apply in the second year succeeding that in which the "net loss" is sustained which second succeeding year is defined in section 206 (b) as the "third year."

"Net losses" sustained in 1922 and 1923.

LAW. Section 206. .... (e) If for the taxable year 1922 a taxpayer sustained a net loss in excess of his net income for the taxable year 1923 (such net loss and net income being computed under the Revenue Act of 1921), the amount of such excess shall be allowed as a deduction in computing net income for the taxable year 1924 in accordance with the method provided in subdivisions (b) and (c) of this section.

(f) If for the taxable year 1923 a taxpayer sustained a net loss within the provisions of the Revenue Act of 1921, the amount of such net loss shall be allowed as a deduction in computing net income for the two succeeding taxable years to the same extent and in the same manner as a net loss sustained for one taxable year is, under this Act, allowed as a deduction for the two succeeding taxable years.

Under the above provisions the net loss for 1922 is to be computed under the 1921 law. The net income for 1923 and the deduction therefrom of the 1922 net loss is also to be computed under the 1921 law. However, any excess of such net loss carried forward to 1924 is to be deducted in accordance with subdivisions (c) and (d) of section 206 of the 1924 law, which have been discussed in the foregoing pages.

Section 206 (f) quoted above provides that a net loss for 1923 (computed under the 1921 law) shall be allowed "to the same extent" and "in the same manner" as a "net loss" is allowed as a deduction, under the 1924 law, for the two succeeding years. Under section 204 of the 1921 law an individual taxpayer (as well as a corpora

See page 744.

tion) was permitted to deduct capital net losses, sustained in trade or business, in computing stautory "net loss." Under section 206-a-2 of the 1924 law such deductions are not allowed to an individual in computing statutory "net loss." If the "net loss" of an individual for 1923 includes capital net losses, and such "net loss" for 1923 can be carried forward only "to the same extent" as a "net loss" is deductible under the 1924 law, the question arises as to whether such capital net loss included in the statutory "net loss" for 1923 can be carried forward to 1924 since under the 1924 law such capital net loss is not allowed as a deduction in computing statutory "net loss."

It is not entirely clear from section 206 (f) that Congress intended to prevent, in the case of an individual, the carrying forward to 1924 and 1925 of a capital net loss, sustained in trade or business and therefore included in a statutory "net loss" for 1923. In a measure such a limitation would be breaking faith with taxpayers. In the absence of any prohibition in the law or regulations, the doubt should be resolved in favor of the taxpayer.

Administrative Provisions-Capital Gains

Special information to be included in returns.

REGULATION. Segregation of capital transactions for the purposes of section 208 (b) is required only where the taxpayer elects to be taxed under that subdivision. Where his total income tax for any taxable year does not exceed 121⁄2 per cent of his net income he will not elect to be so taxed for that year. See article 1651. When a taxpayer elects to be taxed under this section for any taxable year, he must attach to his return of income for such year an accurate statement under oath showing all items of capital gain, capital loss, and capital deductions in such manner as will clearly show the exact amount of his capital net gain for the taxable year. Each capital transaction must be separately shown and the capital items with respect thereto grouped together in order that the capital gain derived or the capital loss sustained from each capital transaction will readily appear. In the case of sales or exchanges of securities or any other property, the statement must show how long the property was held by the taxpayer immediately preceding the sale or exchange. (Art. 1652.)

Collection and payment.

LAW. Section 208.

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... (d) The total tax determined under subdivision (b) or (c) shall be collected and paid in the same manner, at the same time, and subject to the same provisions of law, including penalties, as other taxes under this title.

25 See page 739.

36 See page 741.

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Income from royalties and similar sources is not specifically named in the definition of income in the law, but it is clearly included within the following general clause:

LAW. Section 213.

(a) The term "gross income" includes gains, profits, . . . . and income derived from any source whatever.

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The law provides that the profit which arises from the sale of patents and copyrights must be included as income for the year in which it is received. It has been pointed out on many occasions that this procedure works an unwarranted hardship on inventors and others who have spent considerable time and money in the development of ideas or devices, only to find that on selling them the whole of the increased value must be returned for tax purposes in a single year. It is admitted that a distribution of the increment over the development period would be extremely difficult, but the injustice of the present procedure warrants special treatment of some kind.

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Under the 1918 and prior laws no relief was granted, nor was any effective for the taxable year 1921; but since 1922 the "capital net gain" provision of the law 1 has limited the tax payable to 121⁄2 per cent of the profit, if the patent or copyright has been held for at least two years.2

1 Section 206, 1921 Act; and Section 208, 1924 Act.

2 See further page 739 et seq.

Royalties from Mines, Oil Wells, etc.

Royalties from mines, oil wells, etc., must be accounted for in the year in which they are received by the original recipient. If they are afterwards transferred to another as the result of litigation, the tax originally paid thereon will be adjusted if a claim for credit or refund is filed.

RULINGS. Income from oil royalties must be returned in the taxable year received, even though the title to the producing land is in litigation. If any part of the royalty income is ordered by the court to be paid over to another, any tax previously paid thereon will be credited against any income tax then due under any other return of the taxpayer, and any balance of the excess tax paid will be refunded if proper claim for such refund is made. (C. B. 4, page 95; O. D. 825.) This ruling was later explained as follows:

In the case of a dispute as to the title of oil-producing land, the royalties belong to the true owner. They follow the land and come into existence regardless of the person or activities of the owner. If one collects the royalties thinking he is the owner and then by judgment of court finds that another is the owner, he must surrender the royalties received not as damages but simply because they belong, and belonged from the beginning to the true owner. The one who first received the royalty did so because he thought the land, and therefore, the royalties were his.

Where a patentee obtains a judgment against the infringer of a patent by virtue of which the infringer must account for all profits made through the infringement, the situation is materially different. .. (C. B. 5, page 134; O. D. 1141.)

In the foregoing case the royalties were paid to one who claimed to be the owner of the lands. The obligation to report was clear. In the following case the lessee withheld the payments. It is not likely that the claimant, eventually successful, would have been reporting the income on an accrual basis. Nevertheless. when determined the claimant should be permitted to file amended returns. The only equitable tax is that which would accrue from year to year under the laws in force during those years. Otherwise under the graduated rates in force in the year of realization the government might take several times as much tax as would justly be due. The taxpayer's failure to report would be due to no fault of his and he should not be penalized. The Commissioner has the power to, and should, accept amended returns.

RULING. The taxpayer leased oil land to a corporation under a royalty agreement. The title of the lessor to the land is in litigation 3 For remainder of ruling, see page 755

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