RULING. A invented certain apparatus and secured United States patents thereon. The patents were assigned to a foreign corporation under an agreement by which he retained 40 per cent interest in profits therefrom. Legal title to the patents passed to the company subject to the agreement mentioned. A's interest was recognized by the company and by the United States licensees under the patents. The committee is of the opinion that the agreement should be recognized as giving A a depreciable interest in the patents.

The value of each patent as at March 1, 1913, should be segregated and the depreciation allowable thereon determined on the basis of its own life instead of using as a basis the average life of all the patents and the value of all the patents in bulk. Of the total depreciation allowable for any year, 60 per cent is deductible in the return of the company and 40 per cent in A's return. (C. B. 2, page 142; A. R. M. 35.)

All interest, except on state, municipal and certain United States securities, is to be included in gross income, whether on notes, bank deposits, bonds, mortgages or deeds of trust or other similar obligations of domestic corporations and insurance companies, bonds issued in foreign countries or upon foreign mortgages or like obligations (even though not payable in the United States).

Interest on tax-exempt securities is not to be reported as a part of gross income. The statement showing the number and amount of such securities and the income therefrom, which was required to be submitted with the annual income tax return under the 1918 law, is again required under the 1924 law, although it was not required under the 1921 law.1

Subject to the exceptions stated, not only is all interest received by residents and domestic corporations taxable, but interest received by non-resident aliens and foreign corporations from sources within this country 2 is also taxable-a fact which raises an interesting question of international double taxation.3

The law and procedure regarding interest derived from United States obligations, including securities issued under the Federal Farm

1 [Former Procedure] Prior to 1918,, interest which was entirely exempt from taxation did not have to be reported at all.

2 As defined in section 217 (a-1). See Chapter XLVI.

3

For discussion of the principles involved in the taxation of non-resident aliens, see Chapter XLVI.

Loan Act, will be found in the following chapter. Interest from all other sources is discussed in this chapter.

Interest subject to tax.

....

LAW. Section 213. For the purposes of this title, . . . . (a) The term "gross income” includes gains, profits, and income derived from . . . . interest,

In order to exclude all exempt interest from taxation, taxpayers, particularly banks and other financial institutions, should keep separate ledger accounts for interest from various sources.

Interest due but not collected.—

REGULATION. When interest coupons have matured and are payable, but have not been cashed, such interest payment, though not collected when due and payable, is nevertheless available to the taxpayer and should therefore be included in his gross income for the year during which the coupons matured. This is true if the coupons are exchanged for other property instead of eventually being cashed. Defaulted coupons are income for the year in which paid. ... (Art. 52.)

Owners of bonds should not accrue the interest until there is a reasonable chance of collecting it. Of course, if the taxpayer could collect, but does not, there is no excuse for not reporting the amount accrued.

ACCRUED INTEREST RETURNED AS INCOME WHICH IS NOT SUBSEQUENTLY COLLECTED.-Taxpayers reporting upon the accrual basis should report as taxable income accruals from bonds, real estate mortgages, loans and other obligations when there is a reasonable expectation that such interest will be received in due course. In cases where it develops that the debtor is unable to pay the interest previously entered as income, this interest should be charged off on the taxpayer's books as a bad debt as soon as it is known to be worthless.4

In a ruling under the 1918 law, the Treasury held that a taxpayer could not be permitted to change from an accrual to a cash basis in accounting for interest when such interest was in part

[Former Procedure] Where interest on loans made by a parent corporation to its subsidiary accrued from year to year, but was not paid, the amount thus accrued during a taxable year cannot be considered income to the parent company within the meaning of the Act of August 5, 1909. (C. B. 4, page 286; T. D. 3133.)

uncollectible, but must seek relief by charging off such items as bad debts.5

Interest accrued prior to March 1, 1913, not taxable.—The regulations provide that interest which accrued on or before March 1, 1913, and was subsequently collected, is not taxable.

REGULATION. Any claim existing unconditionally on March 1, 1913, whether presently payable or not and held by a taxpayer prior to March 1, 1913, whether evidenced by writing or not, and all interest which had accrued thereon before that date, do not constitute taxable income, although actually recovered or received subsequent to such date. Interest accruing on or after that date is taxable income. Where an interestbearing claim held on February 28, 1913, is paid in whole or in part after that date, any gain derived from the payment of the claim is taxable. The amount of such gain is the excess of the proceeds of the claim (both principal and interest) exclusive of any interest accrued since February 28, 1913, already returned as income, over the cost thereof (both principal and interest then accrued). However, the gain to be included in gross income where the fair market value of the claim as of March 1, 1913, is greater than the cost thereof, is the excess of the amount received over such value. . . . . (Art. 90.)

Interest on promissory notes of joint-stock land banks.Although interest on Federal Farm Loan bonds is not taxable, interest paid on the promissory notes issued by joint-stock land banks is not exempt.9

Interest on obligations of states and political subdivisions.It will be recalled that the law exempts interest upon "the obligations of a State, Territory, or any political subdivision thereof, or the District of Columbia." [Section 213 (b-4).] For a full discussion, including the definition of "political subdivision," see page 481 et seq.

INTEREST ON SUCH OBLIGATIONS SOLD BETWEEN INTEREST DATES.—

RULING. When interest-bearing obligations of a State or political subdivision thereof are sold between interest dates and the agreement

6

C. B. I-1, page 52; A. R. R. 737.

[Former Procedure] The action of the Income Tax Unit in holding that an item of interest "which accrued prior to March 1, 1913, constituted taxable income in 1915, the year in which received," was reversed on appeal. (C. B. 4, page 102; A. R. R. 375.) See also Plant v. Walsh, 280 Fed. 722, and West Virginia Pulp & Paper Company v. Bowers, 293 Fed. 144.

In a case under the 1909 law, it was finally held that interest_accrued prior to 1909 and paid in 1911 was not taxable. (C. B. 3, page 243; T. D. 3048.) For status of dividends from surplus at March 1, 1913, see Chapter XXXI. See page 480.

7

'C. B. II-2, page 92; I. T. 1806.

of sale specifies a division between the price of the obligation and the accrued interest, the interest which is advanced by the vendor to the vendee is interest on the obligations of a State and is exempt from tax. . . . . (C. B. I-1, page 27; I. T. 1187.)

10

INCOME FROM SALE OR REDEMPTION OF SUCH OBLIGATIONS ISSUED AT A DISCOUNT-WHEN TAXABLE.

RULING. . . . . If the obligations, whether interest bearing or noninterest bearing, were issued at a discount, any excess of the selling price over the cost of the obligations to the vendor is a taxable profit to the extent of such excess, even though the agreement of sale specifies a division between the price of the obligation and the accrued discount. .... (C. B. I-1, page 27; I. T. 1187.)

The foregoing ruling deals with profit on sales. When redeemed by the obligor, the difference between the redemption price and the cost to the holder (if the latter paid as much as, or more than, the original issue price) is held, in the following ruling, to be exempt income.

RULING. The M bank purchased certain 10 year 42 per cent municipal bonds at 96.10 which had been originally issued and sold by the municipality at 94.50. The question is presented as to whether in case the bank sells the bonds before maturity at 98, the profit realized will be exempt in its hands.

Held, that inasmuch as no person other than the municipality can pay the interest borne by the obligations of the municipality (whether such interest is paid at the specified rate or in the form of realized discount) any person selling municipal bonds for an amount in excess of the cost of the bonds to him realizes a taxable profit to the extent of such excess amount even though the bonds were issued at a discount.

If, therefore, the bank sells at $98 the municipal bonds issued at $94.50 and purchased by it at $96.10, it will derive a taxable profit of $1.90 on each bond sold. If, however, it holds the bonds to maturity and receives $100 the difference between the purchase price of the bonds and the amount received, or $3.90, will represent exempt income to it. (C. B. 4, page 31; O. D. 762.)

Interest on savings bank deposits.11_

REGULATION.

Interest credited on savings bank deposits, even though the bank nominally has a rule, seldom or never enforced, that it may require so many days' notice in advance of cashing depositors' checks, is income to the depositor when credited. . . . . (Art. 52.)

Counsel for the American Bankers Association has expressed the opinion that so-called interest on savings bank deposits is really dividends and thus exempt from the normal tax.

11

19 See also C. B. I-1, page 29; I. T. 1337; and III-29-1672; I. T. 2050. [Former Procedure] Under a 1914 ruling, the Treasury sought to require taxpayers reporting on a cash basis to report accrued but unpaid interest on bank deposits. See Income Tax Procedure, 1922, page 667, footnote.