(2) establishes a sinking fund or reserve for the retirement of such indebtedness during the taxable year, and sets aside in such fund or reserve an amount for the retirement of such indebtedness—

in determining the undistributed adjusted net income for the taxable year, a deduction from the adjusted net income is allowable in a reasonable amount in respect of the amount so paid or set aside in such fund or reserve during the taxable year.

The amount allowable as a deduction in any case must be reasonable, considering the nature, purposes, scope, conditions, amount, maturity, and other terms of the indebtedness. No deduction is allowable unless it appears, either from the covenants of the obligations or from a recognized business and accounting practice respecting the retirement of such indebtedness, that provision for retirement must be made out of earnings for the taxable year before distribution of such earnings may be made. The reasonableness of the deduction shall be determined by existing conditions known at the close of the taxable year. The fact that amounts have not been used or set aside in prior years will not entitle the taxpayer to deduct in any taxable year a greater amount than would otherwise be allowable. Amounts paid or set aside to discharge current liabilities for expenses, salaries, wages, taxes, interest, the purchase of any property for resale, dividends, balances due brokers, bank or other commercial loans, or any other current liability (whether represented by negotiable instruments, balances on account, or otherwise) do not constitute allowable deductions. This is true as respects liabilities which are payable at the convenience of either the debtor or the creditor, or on the demand of either.

No deduction will be permitted under this article with respect to any item for which a deduction is otherwise allowable under Title IA or Title I of the Act or under any applicable prior income tax Act.

A resolution, specifying the particular indebtedness to be retired, the plan of retirement, and the specific assets to be used for that purpose, passed by the board of directors or corresponding authority during the taxable period or prior thereto, will be considered sufficient to meet the statutory requirement that the amounts must be "set aside." A certified copy of such resolution must accompany the return on Form 1120H.

The burden of proof will rest upon the taxpayer to sustain the deduction claimed. Therefore, the taxpayer must furnish the information required by the return, and such other information as the Commissioner may require in substantiation of the deduction claimed.

ART. 351-5. Rate of surtax.-The surtax is to be computed at the rate of 30 per cent upon the amount of the undistributed adjusted net income not in excess of $100,000, and at the rate of 40 per cent upon the amount of the undistributed adjusted net income in excess of $100,000.

ART. 351-6. Illustration of computation of undistributed adjusted net income and surtax. The method of computation of the adjusted net income and undistributed adjusted net income as outlined in article 351-3 may be illustrated as follows:

The M Corporation, a personal holding company, finds the following facts relating to 1934:

(a) Taxable net income, as computed under Title I, amounts to $100,000.

(b) Dividends received from taxable domestic corporations amount to $40,000, of which $25,000 was from another personal holding company.

(c) Income and excess-profits taxes imposed by section 13 (a) and section 702, amount to $13,750 and $1,250, respectively.

(d) 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, amount to $1,000.

(e) No gains from sales or exchanges of capital assets were realized during the year but losses in the amount of $11,000 were sustained, of which only $2,000 was allowed under section 117 (d) as a deduction in computing the taxable net income, thus leaving a balance of $9,000 of the $11,000 item of capital losses not allowable as a deduction from 1934 gross income.

The "adjusted net income " of the M Corporation, as contemplated in section 351 (b) (3), is as follows:

To the net income ($100,000) is added the dividend deduction ($40,000) taken in determining such net income, thus making a total of $140,000. From this total should be subtracted the aggregate of the above items, $13,750, $1,250, $1,000, and $9,000 (a total of $25,000), which leaves a resulting "adjusted net income" of $115,000.

In addition to the above-stated facts, the M Corporation set aside $5,000 of its "adjusted net income " ($115,000) to apply toward the retirement of an indebtedness of $50,000 incurred prior to January 1, 1934; and also distributed to its stockholders $30,000 as dividends during the taxable year 1934.

In determining the "undistributed adjusted net income," as contemplated in section 351 (b) (2), there will be subtracted from the "adjusted net income" ($115,000), the $53,000 aggregate sum of

the following items: (a) 20 per cent of the $90,000 excess of the $115,000 adjusted net income over the $25,000 part of the $40,000 dividend income of the M Corporation, received during the year from another personal holding company, 20 per cent of $90,000, or $18,000; (b) the $5,000 item set aside to apply toward the retirement of an indebtedness of $50,000, incurred prior to January 1, 1934; and (c) the $30,000 of dividends distributed to its stockholders during the taxable year 1934. This leaves $62,000 ($115,000 less $53,000) as the "undistributed adjusted net income," contemplated in section 351 (b) (2), on which the 30 percent surtax rate of bracket (1) of section 351 (a) applies, making the 1934 surtax of the M Corporation, $18,600.

ART. 351-7. Payment of surtax on pro rata shares.-The surtax imposed by section 351 does not apply to any taxable year if every shareholder includes, at the time of filing his return, in his gross income his entire pro rata share of the adjusted net income of the corporation for the taxable year of such corporation ending with or during his taxable year.

Ordinarily it is not necessary for a corporation to distribute all of its gains and profits in order for section 351 to be inapplicable. In the illustration given in article 351-6, the surtax imposed by section 351 would not apply if the corporation distributed to its shareholders at least 92 per cent of its net income or $92,000. If, however, the corporation made no distribution and all the shareholders elected to be taxed under the provisions of section 351(d), the entire “adjusted net income" of $115,000 must be reported by the shareholders. Thus, it will be seen that, in most cases, it will be advantageous for the corporation to make actual distributions to its shareholders.

ART. 351-8. Return and payment of tax.-A separate return is required for the surtax imposed under section 351. Such return shall be made on Form 1120H. In the case of a personal holding company which is a domestic corporation, the return is required to be made within the time prescribed in section 53 and in the case of a foreign corporation within the time prescribed in section 235. The tax shown by the corporation on its return must be paid in the case of a domestic corporation within the time prescribed in section 56 and in the case of a foreign corporation within the time prescribed in section 236. The same provisions of law relating to the period of limitation for assessment and collection which govern the taxes imposed by Title I also apply to the surtax imposed under Title IA. However, since the surtax imposed under Title IA is a distinct and separate tax from those imposed under Title I, the making of a return under Title I will not start the period of limitation for assessment of the surtax imposed under Title IA. If the corporation subject to section

351 fails to make a return, the tax may be assessed at any time. If the Commissioner finds a deficiency in respect of the tax imposed by section 351, he is required to follow the same procedure which applies to deficiencies in income tax under Title I. The penalties applicable to the income taxes imposed under Title I, as well as the provisions of Title I relating to interest and additions to the tax, also apply to the surtax imposed by section 351. The administrative provisions applicable to the surtax imposed by section 351 are not confined to those contained in Title I but embrace all administrative provisions of law which have any application to income taxes.

ART. 351-9. Determination of tax, assessment, collection.-The determination, assessment, and collection of the tax imposed by section 351, and the examination of returns and claims in connection therewith, will be made under such procedure as may be prescribed from time to time by the Commissioner.

CHAPTER XXXV

GENERAL PROVISIONS-DEFINITIONS

Title VI-General Provisions

SEC. 801. DEFINITIONS.

(a) When used in this Act

(1) The term "person means an individual, a trust or estate, a partnership, or a corporation.

(2) The term " corporation includes associations, joint-stock companies, and insurance companies.

(3) The term “partnership" includes a syndicate, group, pool, joint venture, or other unincorporated organization, through or by means of which any business, financial operation, or venture is carried on, and which is not, within the meaning of this Act, a trust or estate or a corporation; and the term partner " includes a member in such a syndicate, group, pool, joint venture, or organization.

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(4) The term "domestic" when applied to a corporation or partnership means created or organized in the United States or under the law of the United States or of any State or Territory. (5) The term "foreign when applied to a corporation or partnership means a corporation or partnership which is not domestic. (6) The term fiduciary' means a guardian, trustee, executor, administrator, receiver, conservator, or any person acting in any fiduciary capacity for any person.

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(7) The term "withholding agent means any person required to deduct and withhold any tax under the provisions of section 143 or 144.

(8) The term "stock" includes the share in an association, joint-stock company, or insurance company.

(9) The term "shareholder." includes a member in an association, joint-stock company, or insurance company.

(10) The term "United States when used in a geographical sense includes only the States, the Territories of Alaska and Hawaii, and the District of Columbia.

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(11) The term Secretary" means the Secretary of the Treasury.

(12) The term "Commissioner " means the Commissioner of Internal Revenue.

(13) The term

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collector" means collector of internal revenue.

(14) The term taxpayer" means any person subject to a tax imposed by this Act.

(b) The terms "includes" and "including " when used in a definition contained in this Act shall not be deemed to exclude other things otherwise within the meaning of the term defined.

ART. 801-1. Classification of taxables.-For the purpose of taxation the Act makes its own classifications and prescribes its own standards of classification. Local law is of no importance in this connection.