dends, interest, annuities, and gains from the sale of stock or securities; and, second, more than 50 per cent in value of whose outstanding stock was owned, directly or indirectly, at any time during the last half of the taxable year by or for not more than five individuals. The only corporations specifically exempt from this tax are as follows: (1) Corporations exempt from taxation under section 101 of Title I; (2) banks and trust companies (incorporated under the laws of the United States, or of any State or Territory), a substantial part of whose business is the receipt of deposits; (3) life insurance companies; and (4) surety companies.

It is the nature of the gross income and the ownership of the outstanding stock which determine the classification as a personal holding company, and the several conditions with respect to both must be satisfied to bring a corporation within the classification. Gross income must be determined for the entire taxable year and the ownership of the stock outstanding must be determined according to its ownership at any time during the last half of the taxable year. Inasmuch as such circumstances can vary from year to year, a corporation may constitute a personal holding company for some years and not for other years. In that case, the surtax liability shall be determined under section 351 only for the years in which the corporation comes within the classification as a personal holding company, while the liability for surtax as to the other years will depend upon whether the corporation comes within the provisions of section 102 with respect to such years.

The gross income for purposes of section 351 means the gross income as computed under sections 22, 204, and 231 and the articles thereunder, for purposes of the taxes imposed by Title I. Accordingly, items excluded from the gross income under Title I are not to be included in determining gross income under section 351. Gross income is not synonymous with gross receipts. For example, in the case of a sale or exchange of property, it includes only the excess of the amount realized therefrom over the adjusted basis provided for in section 113 (b). It does not include gains which are not recognized under section 112 (b). In the case of a corporation reporting on the installment basis, it includes only that portion of the gain returnable as income under section 44. In the case of a manufacturing, merchandising, or mining business, "gross income" means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources. In determining gross income, subtractions should not be made for depreciation, depletion, selling expenses, or losses, or for items not ordinarily used in computing the cost of goods sold. Sales of capital

assets as defined in section 117 must be treated as separate transactions and only those sales which individually resulted in profits shall be considered in determining the gains derived from such source. Gains from all transactions involving stock in trade, etc., are determined for the taxable year as a whole instead of separately.

From the standpoint of the nature of the gross income, a corporation comes within the definition of a personal holding company for any taxable year when 80 per cent or more of its gross income for such taxable year was derived from the following sources:

(1) Royalties.-The term "royalties" includes amounts received for the use of or for the privilege of using patents, copyrights, secret processes and formulas, good will, trade marks, trade brands, franchises, and other like property. It does not include rents, nor overriding royalties received by an operating company. As used in this paragraph the term "overriding royalties " means amounts received from a sublessee by the operating company which originally leased and developed the natural resource property in respect of which such overriding royalties are paid.

(2) Dividends.-The term "dividends" means dividends as defined in section 115 (a). It does not include stock dividends, liquidating dividends, or other capital distributions referred to in section 115 (c), (d), and (f).

(3) Interest. The term "interest" means any amounts received for the use of borrowed money which are includible in gross income under Title I.

(4) Annuities.-The term "annuities" refers only to annuities to the extent includible in the computation of gross income under Title I.

(5) Gains from the sale of stock or securities.-The term "gains from the sale of stock or securities" applies to all gains (including gains from liquidating dividends and other distributions from capital) from the sale or exchange of stock or securities includible in gross income under Title I. The term "stock or securities" includes shares or certificates of stock or interest in any corporation (including any joint-stock company, insurance company, association or other organization classified as a corporation by the Act), certificates of interest or participation in any profit sharing agreement or in any oil, gas, or other mineral royalty or lease, collateral trust certificates, voting trust certificates, stock rights or warrants, bonds, debentures, certificates of indebtedness, notes, car trust certificates, bills of exchange, obligations issued by or on behalf of a Government, State, Territory, or a political subdivision thereof, etc. In the case of " regular dealers in stock or securities" the term does not include gains derived from the sale or exchange of stock or

securities made in the normal course of business. The term “ regular dealers in stocks or securities" means corporations with an established place of business regularly engaged in the purchase of stock or securities and their resale to customers. A corporation which is a regular dealer in stock or securities but which buys or sells or holds stock or securities for investment or speculation is not a dealer with respect to such stock or securities.

From the standpoint of the ownership of the outstanding stock, a corporation comes within the definition of a personal holding company for any taxable year if at any time during the last half of the taxable year more than 50 per cent in value of the outstanding stock was owned, directly or indirectly, by or for not more than five individuals. The ownership of the stock shall be determined in accordance with the following rules:

(a) All forms and classes of stock, however denominated, which represent the interests of the shareholders, members, or beneficiaries in the corporation shall be taken into consideration. For the purpose of determining such ownership, the Act provides that stock owned, directly or indirectly, by a corporation, partnership, estate or trust shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries. For example, if A and B, two individuals, are the exclusive but equal beneficiaries of a trust or estate, and, if such trust or estate owns the entire capital stock of the X Corporation, and, if the X Corporation in turn owns the entire capital stock of Y Corporation, then the stock of both the X Corporation and the Y Corporation shall be considered as being owned equally by A and B as the individuals owning the ultimate beneficial interests therein.

(b) The stock outstanding only during the last half of the taxable year shall be taken into consideration. However, and in the event of any change in the stock outstanding during such period, whether in the number of shares or classes of stock or whether in the ownership thereof, the conditions existing immediately prior and subsequent to each change must be taken into consideration, since a corporation comes within the classification if the statutory conditions with respect to stock ownership are present at any time during the period specified.

(c) The stock owned by an individual shall include all stock in the same corporation owned, directly or indirectly, by the members of his family. For this purpose the family of an individual shall include only his brothers and sisters (whether by the whole or halfblood), spouse, ancestors, and lineal descendants. The Act provides that this rule shall be applied in such manner as to produce the smallest possible number of individuals owning, directly or indi

rectly, more than 50 per cent in value of the outstanding stock. For example, the M Corporation at some time during the last half of the taxable year had 1,800 shares of outstanding stock, 450 of which were held by various individuals having no relationship to one another and the remaining 1,350 were held by 50 shareholders having relationships and individual share holdings as follows:

In the above example by applying the statutory rule, five individuals owned more than 50 per cent of the outstanding stock as follows:

A (including AF, AW, AB, AS, ASHS)
B (including BF, BW, BB, BS, BSHS)

CW (including C, CS, CWF, CWB).
DB (including D, DF, DBW)-
EWB (including EW, EWF, EWBW).

Total, or more than 50 per cent_

160

160

220

200

170

910

Individual A represents the obvious case where the head of the family owns the bulk of the family stock and naturally is the head of the group. Individual B represents the case where he is still head of the group because of the ownership of stock by his immediate family. Individuals C and D represent cases where the individuals fall in groups headed in C's case by his wife and in D's case by his brother because of the preponderance of holdings on the part of relatives by marriage. Individual E represents the case where the preponderant holdings of others eliminate that individual from the group.

(d) In determining whether the statutory conditions with respect to stock ownership are present at any time during the period specified, the phrase "in value " shall, in the light of all the circumstances, be deemed the value of the corporate stock outstanding at such time (not including treasury stock). This value may be determined upon the basis of the company's net worth, earning and dividend paying capacity, appreciation of assets, and any other factor having a bearing upon the value of the stock. If a value of stock is used which is greatly at variance with that reflected by the corporate books,

the evidence upon which such valuation is based should be filed with the return. In any case where there are two or more classes of stock outstanding, the total value of all the stock should be allocated among the different classes according to the relative value of each class therein.

ART. 351-3. Computation of undistributed adjusted net income.—In ascertaining the tax basis for personal holding companies, the “adjusted net income " is first computed. This is accomplished by adding to the corporate net income, as defined in Title I, the amount of dividends received from domestic corporations which are deductible under section 23 (p), and by subtracting therefrom (a) Federal income, war-profits, and excess-profits taxes paid or accrued, but not including the surtax imposed by section 351, (b) contributions or gifts not otherwise allowed as a deduction to or for the use of donees described in section 23 (o) for the purposes therein specified, and (c) losses from sales or exchanges of capital assets which are disallowed as a deduction by section 117 (d). The foreign tax credit permitted by section 131 with respect to the taxes imposed by Title I is not allowed with respect to the surtax imposed by section. 351. However, the deduction of foreign taxes under section 23 (c) is permitted for the purposes of the surtax even if for the purposes of the corporate tax imposed by Title I a credit for such taxes is taken.

The "undistributed adjusted net income " is computed by subtracting from the "adjusted net income " described above, (a) an amount equal to 20 per cent of the excess of the adjusted net income over the amount of dividends received from personal holding companies which are allowable as a deduction for the purpose of the tax imposed by section 13 or 204, (b) reasonable amounts used or set aside. to retire indebtedness incurred by the taxpayer prior to January 1, 1934 (see article 351-4), and (c) any dividends paid during the taxable year.

The credit against net income for certain interest received upon obligations of the United States, or of corporations organized under Act of Congress, is not allowable for purposes of the surtax.

ART. 351-4. Amounts used or set aside to retire indebtedness incurred prior to January 1, 1934.-If, pursuant to a bona fide plan for the retirement of its bonds, debentures, or similar obligations representing indebtedness incurred prior to January 1, 1934, for the purpose of raising capital (or assumed prior to that date in connection with the acquisition of capital assets by which such indebtedness is secured) the taxpayer

(1) retires during the taxable year an amount of such indebtedness, or