as to the part accumulated prior to March 1, 1913, and free from the normal tax as to the part earned after March 1, 1913.1

Dissolution of limited partnerships.-The procedure in the case of the dissolution of limited partnerships of the corporation type2 is the same as that for corporations. When there is a large surplus at the date of distribution it must be borne in mind that the normal income tax has been paid on all accumulations since March 1, 1913. If securities in a new corporation or limited partnership are received in exchange, the excess of the fair value of the new securities over the value of the old shares at March 1, 1913, or cost if acquired after that date, will be taxable as net income for the year when realized. If the new securities are delivered to the old partnership, instead of direct to the shareholders of the partnership, the old partnership will not be taxed unless the new securities exceed in par value the book value of the property disposed of, and not then if the fair value of the new securities does not exceed the book value of the assets transferred.

If the old partnership distributes the new securities to its shareholders they will have to account therefor the same as if they received them direct from the new corporation.

In any event the old partnership should distribute its surplus as a dividend up to the full amount shown on the books and thus afford its shareholders full opportunity to receive credit for the normal tax paid.

Proceeds of Sale of Rights to Subscribe to Stock

Considered Appreciation

One peculiar form in which appreciation in the value of property sometimes asserts itself is the privilege given to a stockholder to subscribe to a new issue of stock upon partic

'See Chapter XV as to dividends.

'See Chapter XVII.

ularly favorable terms. These "rights" in some cases undoubtedly represent an increase in the value of the stockholder's interest in the company and, as is shown in the following regulation, the Treasury has attempted to tax the proceeds of the sale of such rights as income.

REGULATION. In cases wherein corporations desiring to secure additional capital propose to issue and sell further shares of stock, reserving to their stockholders the right to subscribe for, at par or any other stipulated price, a certain number of shares of the new stock issue, proportioned to the number previously held, and if such stockholders shall sell their rights, it will be held that the proceeds of such sale are in their entirety income for the year in which the rights are sold, and should be so returned by the stockholders, whether they be individuals or corporations.' (Reg. No. 33, 1918, ¶ 359.)

This regulation is too broad. In some cases its application accomplishes substantial justice, but, on the other hand, there are numerous instances in which the issuance of the rights operates to depreciate the value of the remaining shares. Where this is true, the realization from the sale of rights is certainly not all gain or profit. The principle involved is very much the same as that which governs stock dividends, for which see Chapter XVI. In some cases the courts have held the proceeds of such sales to be wholly capital.

Proceeds of Sale of Goodwill Are Taxable

When an individual or partnership sells a business and its goodwill is an element, part of the purchase price is paid for goodwill, and the question arises as to the taxable status of the vendor.

The question is not the same whether cash or securities. are received, because in one case there is a realization and the question settles down to the basis of the tax; in the latter case no actual realization, as a rule, takes place.

Assume that in 1918 A sold his business to B for $100,000

'The same position is taken in Reg. No. 33, 1918, ¶ 61.

cash. The value of the net taxable assets was $50,000; the balance represented goodwill. A established the business in 1913, so no question of March 1, 1913, value arises. The Department would certainly tax A upon a basis of $50,000 realized profit, taxable at 1918 rates.

If A sells to a corporation it can hardly be expected that the stock he receives will be worth par value. Goodwill usually is valued on a hoped-for basis. Hopes are not taxable subjects. If A sells out to others, under the regulations he will be required to account for the fair value of the stock he receives. If he incorporates his own business he cannot be charged with receiving something he did not have before.1

'But see letter to B. F. Foster, page 269.

CHAPTER XII

INCOME FROM ROYALTIES AND PATENTS

Income from royalties and similar sources is not specifically named in the definition of income given in the law but is clearly included within its terms. The following general statement appears in the regulations.

REGULATION. Royalty paid to a proprietor by those who are allowed to develop or use property, or operate under some right belonging to him, is to be accounted for as income. (Reg. No. 33, 1918, 59.)

Royalties from Mines, Oil Wells, etc.

Royalties subject to depletion charges.-The owner of a mine, an oil well or other similar property operated on a royalty basis must return as income his royalties received, but is permitted to deduct expenses and to charge against receipts depletion allowances based on the full value of his property at March 1, 1913, if purchased before that date, or on the basis of the capital originally invested if purchased thereafter.1 For

'Von Baumbach v. Sargent Land Co., 242 U. S. 503.

[Former Procedure] Full depletion allowances have been permissible deductions only since 1916. The 1913 law contained a provision restricting such charges to 5 per cent of the gross value of the output of the mine, and in spite of the fact that this worked inequitably in some cases the courts decided that it was constitutional. The 1909 law permitted no deduction at all for depletion. As it is still frequently necessary to pass upon returns made under the 1913 law, the following decision issued February 12, 1915, is of interest:

"In the case of mines operated by a lessee on a royalty basis, it is held that the lessor in disposing of his ores or natural deposits on the basis of royalties has a measure of profit in every ton of ore disposed of in this way, and that so much of the gross receipts on account of royalties as is in excess of depletion, not exceeding 5 per cent of the gross value of the output at the mine, plus any incidental expenses to which

a full discussion of the topic of depletion as an allowable deduction, consult Chapter XXVI.

After the value at March 1, 1913, is determined, a proper calculation must be made as to how much of the royalties received is capital and how much income. The part that is income should be reported and the portion that is capital should be ignored in the return.

Royalties from coal lands. In the anthracite fields many owners of coal lands have granted perpetual "mining leases" to operators. The Supreme Court of Pennsylvania has held these transfers to be "sales." In all cases the revenue therefrom (usually a fixed rate per ton mined) is known as "royalties." Under the 1916 and subsequent laws the owners of coal lands, or those to whom a "royalty" is being paid, are entitled to receive in cash, free from income tax, an amount equal to the fair value of the property on March 1, 1913. This valuation is assumed to be capital. After such principal sum is provided for, the balance of the collections is net income and is subject to the income tax. If the rate of royalties is a substantial one, it is probable that of the royalties received each year part is capital and part taxable income.

Mining (minimum) royalties received in advance.-In most mining districts it is customary for owners of the lands

the corporation may be subject, is income within the meaning of the federal income tax law and should be so returned by the lessor." T. D. 2152.)

The above ruling was obviously defective because it ignored the fact that there are many cases where royalties received have no "measure of profit" in them. Every purchaser or owner of a mine or oil well does not have a bonanza. He may have paid a high price for his property, hoping to secure royalty returns which would show a handsome profit, but his hopes may fade and disappear and he may be glad to get his original capital back without interest.

'For citations see Sargent Land Co. case, 242 U. S. 503.