period, the 1918 law provides1 that it shall have as a credit against its 1918 tax an amount equal to the credits of corporations engaged in a similar business. But its war-profits credit shall be $3,000 plus 10 per cent of the invested capital for the taxable year,

LAW. Section 311. (d) .... if (2) 50 per centum or more of its gross income (as computed under section 233 for income tax purposes) consists of gains, profits, commissions, or other income, derived from a government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.

This provision is equitable, as there were no corporations. which could be said to be engaged in 1911-13 in business similar to war business.

Invested capital "relief" denied. In the regulations under the 1917 law and in the 1918 law itself certain provisions are made for the equalization of the invested capital of corporations without which undue hardship would ensue. The benefit of the relief sections in the 1918 law is denied to a corporation in any case.

(d) .

· ...

LAW. Section 327. (2) in which 50 per centum or more of the gross income of the corporation for the taxable year (computed under section 233 of Title II) consists of gains, profits, commissions, or other income, derived on a cost-plus basis from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive.

May not qualify as a personal service corporation.-The privilege of qualifying as a personal service corporation (which means reporting as a partnership) is denied to a corporation, LAW. Section 200. 50 per centum or more of whose gross income consists . . . . (2) of gains, profits, commissions, or other income, derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, both dates inclusive;

....

This may or may not be fair, depending on the circum

stances.

'Section 311 (c).

CHAPTER XI

INCOME FROM THE APPRECIATION OF

PROPERTY

VALUES

It is hardly accurate to state without reservation that unrealized appreciation is not taxable under an income tax law, but that realized appreciation is taxable. The law purports to tax "net income," but in the absence of a comprehensive definition of net income in the law, it is not easy to determine when appreciation was intended by the lawmakers to be taxed and when not. Moreover, even if their intentions were clearly enough expressed in the law, the Supreme Court might hold that unrealized appreciation may ever be taxed as income. In fact it is not certain that the Supreme Court will hold that all realized appreciation even if accrued since March 1, 1913, is taxable income.

Is Appreciation in Value of Property Income?

Before proceeding to a discussion of the taxability of appreciation under an income tax law it is desirable to point out some of the difficulties which surround the determination of taxable income itself. It will never be a simple matter to decide off-hand that a certain gain is taxable but that another gain is not taxable-that one item of cash receipts is taxable but that another item is not taxable. If it is difficult for individual taxpayers to decide one or two points, how almost impossible must it be for lawmakers to enact a law which will control tens of thousands of cases all unlike.

LAW. Section 212. (a) That in the case of an individual the term "net income" means the gross income as defined in section 213, less the deductions allowed by section 214.

We then find that Section 213 (a) states that:

LAW. Section 213. . . . . the term "gross income❞—

(a) Includes gains, profits, and income derived from . . . . businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property;

It is obvious that nothing taxable is left untaxed and it is equally obvious that the words "gains, profits and income" might be construed by a zealous tax collector to tax unrealized as well as realized gains and profits.

But the Supreme Court and our lower courts have been reluctant to define anything as income unless it bears all (not part only) of the evidences of true income.

In the Maryland Casualty Co. case1 the court said:

DECISION. . . . . the courts have not departed, unless it expressly appears otherwise, from a construction of the law in accord with an intention to reach the actual and not the potential income of the corporation. . . . . One cannot be said to receive an income of defined proportions until he balances receipts and deductions at the end of a stated period and ascertains not what is due but what has been actually received.

It may not be possible to make a general rule which will enable us to determine when we can be charged with actual profits or income and when what we have is potential only. It is, however, fairly safe to say that when there is a real doubt as to whether a gain or profit has been actually realized the doubt will be decided in favor of the taxpayer.

There are wide variations in theory and practice among economists, financiers and legislators as to the proper meaning of the term income. Particularly with reference to appreciations in the value of property are there differences of opinion, some contending that appreciation is true income and others denying it. Concerning increases in the value of property in the form of stock-in-trade of a business enterprise there is little

'Maryland Casualty Co. v. U. S. Court of Claims, No. 33191, decided February 12, 1917.

dispute; but, granting that such increases are income, many contend that the situation is entirely different in the case of increments of value accruing to pieces of property which are not a part of one's stock-in-trade, such, for example, as securities acquired by gift or purchase and held primarily as investments. Appreciations in the value of property of this type, many contend, are not items of income in any real sense and they cite the practice in England and Germany as precedents for excluding them from taxable income. Some even predict that the United States Supreme Court, when it comes face to face with this question, will draw a distinction between property purchased to be resold at a profit and property purchased primarily as an investment and will decline to include in the definition of income the appreciation in the value of property of the latter class. The average person considers the profit realized from the sale of property in excess of its cost to be income and does not object to assessment of the profit for income tax purposes. To tax it does no violence to accounting principles, provided care is taken to levy the tax only when there has been a definite realization.

As explained in Chapter X,1 it is not a simple matter to draw a strictly logical line of division between profits from dealings in property and profits from business. The solution here arrived at is to treat in this chapter merely the subject of profits from appreciation in the value of property which is of the nature of fixed assets or of investments entered into as more or less isolated transactions. Appreciations in the value of property which is ordinarily considered stock-in-trade as well as all the miscellaneous items connected with income from business and dealings in property are considered in the chapter which precedes this.

Definition of income under early United States law. The income tax law of 1867 defined income as "gains, profits,

and income whether derived from any kind of property rents, interest, dividends or salaries, or from any profession, trade, employment or vocation. . . . or from any other source whatever." In the famous case of Gray v. Darlington (15 Wall 63), Justice Field of the Supreme Court of the United States gave the following as the court's interpretation of this law:

DECISION. Except, however, in certain cases mentioned, and in cases of sales of real property, the statute only applies to such gains, profits and income as are strictly acquisitions made during the year preceding that in which the assessment is levied and collected. The mere fact that property has advanced in value between the date of its acquisition and sale does not authorize the imposition of the tax on the amount of the advance. Mere advance in value in no sense constitutes the gains, profits, or income specified by the statute. It constitutes and can be treated merely as increase of capital. The rule adopted by the officers of the revenue in the present case would justify them in treating as gains of one year the increase in value of property extending through any number of years, through even the entire century. . . . . We are satisfied that no such result was intended by the statute.1

Surplus arising out of reappraisals may be taxable income. -Increased valuations arising out of the writing up of book values are not subject to income or excess profits taxes, unless the taxpayer has adopted the inventory method as prescribed by Sections 202 (a-2)2 and 203. In certain cases

[British Practice] Under the English income tax law this contention is sustained. In the case of California Copper Syndicate v. Haines, 6 Fraser 894, the court said:

"It is quite a well-settled principle in dealing with questions of assessment of income tax, that where the owner of an ordinary investment chooses to realize it, and obtains a greater price for it than he originally obtained it at, the enhanced price is not profit in the sense of the income tax law. But it is equally well settled that enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business."

And again in Assets Co. v. Inland Revenue, 24 R. 578, the court said: "So where a person buys a doubtful debt and recovers a larger sum than he paid for it, the gain is not profit in the sense of the income tax law, unless the purchaser is making a trade of buying such debts." 'See page 220.