peared on the books during the years 1911, 1912 and 1913. Adjustments as of March 1, 1913, can hardly be made without giving due attention to the years immediately preceding.

The determination of invested capital means an inquiry into assets, liabilities and net worth. Many corporations made up their excise and income tax returns without regard to the effect on assets or liabilities. The result is that many corporations for the first time find that the connection between the two is a vital one and that items which seemed to be unimportant when dealing with low income tax rates become of great importance when applied to an excess profits tax. It may be the case, therefore, that amended income tax returns back to 1913 and amended excise tax returns for 1909 to 1912 will be necessary to clear up apparent incongruities.

It is true that March 1, 1913, revaluations which involve appreciation will not increase invested capital, but if revaluations as of March 1, 1913, serve to restore to the books items of cost which were written off before that date, the adjusted asset accounts will be included as items of invested capital.

Balance sheets as of the beginning of the calendar years 1911, 1912 and 1913 (or the fiscal years ending within those years) should be prepared from the books.1 The various items of assets, liabilities, capital and surplus should be compared with the comments on the same class of items discussed elsewhere in this book and any necessary adjustments should be made.

After the balance sheets are adjusted the average of the three years should be calculated. Upon this average will be based one of the most important credits in the determination of the war profits tax for the taxable year, viz., the 10 per cent credit which will be allowed for the additional invested

'RULING. "In those cases where the taxpayer has established a fiscal year in effect during the pre-war period, it will be permissible in ascertaining the amount of the capital invested and the percentage of profit, to prorate the amounts pertaining to the respective fiscal years in arriving at the amounts applicable to the calendar_years." (Letter to Wollman and Wollman from Deputy Commissioner Speer, February 26, 1918.)

capital contributed or allowed to remain in the business between the average pre-war date and the beginning of the taxable year. If the invested capital at the beginning of the taxable year is less than the average pre-war capital the war profits credit for the taxable year will be reduced by 10 per cent thereof.

LAW. Section 326 (d). The average invested capital for the prewar period shall be determined by dividing the number of years within that period during the whole of which the corporation was in existence into the sum of the average invested capital for such years.

This means that changes in capital during the year (by days and months) will be added to or deducted from the capital at the beginning of each pre-war year. After the average for each year is determined the total of the three averages will form the sum of the average invested capital.

Adjustments of pre-war assets.-There are several items of assets which will require adjustment for the pre-war period differing from that for the taxable year.

CASH SURRENDER VALUE OF LIFE INSURANCE.-Life insurance premiums paid on policies insuring the lives of officers are not deductible expenses under the 1918 law. In the prewar period such items were allowable deductions. If the items were claimed as deductions in excise tax or income tax returns the surrender value of the policies would not be an asset.

PLANT ASSETS.-Revaluations involving appreciation are not allowable in the taxable nor in the pre-war period. If adjustments have been made since the pre-war period in depreciation, obsolescence, restoration of items incorrectly charged off, etc., the items should be examined to see if any of the entries affect the pre-war accounts.

GOODWILL AND PATENTS.-When paid for in stock or shares goodwill, patents and other items of intangible property

are included as invested capital for the taxable year not in excess of cash value or 25 per cent of the outstanding stock. If the book value is in excess of such 25 per cent or cash value it should be reduced not only for the taxable year but also for the pre-war period.

Adjustment of pre-war capital stock and surplus.—

UNDIVIDED PROFITS.-The balance of the undivided profits account for each year should be carried forward to the following year and form part of the invested capital for that year.

Adjustment of pre-war liabilities and reserves.

Reserves for TAXES.-Federal excise taxes paid were allowable deductions during the pre-war period, but reserves for taxes were not. Therefore any reserves carried as liabilities should be deducted.

DIVIDEND RESERVES.-Dividends do not reduce invested capital until dates of payment. Therefore dividend reserves should be ignored and payment dates should be followed.

CHAPTER XXXV

WHEN INVESTED CAPITAL CANNOT SATISFACTORILY BE DETERMINED

In its most favorable aspect a tax based on capital values will cause inequalities, even though there be an agreement between the taxing authorities and taxpayers as to the basis of determining what is and what is not capital. But if no such agreement is possible because many taxpayers are unable to furnish trustworthy information regarding their own capital values, the government on its part cannot lay down rules for the determination of capital which will work even approximate justice in many cases.

Taxpayers frequently are not at fault in their inability to supply information which can readily be measured by the yardstick used for the measurement of the capital of other taxpayers. Until 1917 no controlling reason existed for the placing of specific values upon assets. One manufacturer might have written down the value of his plant on his books to $1—and he was commended for his sound and conservative business methods. Another manufacturer might reappraise all his assets at the highest possible valuation, appraise his goodwill at a very high value and sell out to a corporation, owned by himself, on the basis of the high values. Such a man was not regarded as conservative; neither was he regarded as unsound.

Under the 1917 law, literally interpreted, the conservative man was penalized, the other was favored. In other words, the law flew in the face of sound business methods and placed a premium upon overvaluations.

The legal status of the regulations under the 1917 law is an interesting one. Unquestionably the regulations are more liberal than the law itself. Such being the case it is hardly

possible that a taxpayer would appeal from a decision of the Commissioner, unless it were felt that relief as defined by the regulations had been refused. But could it be expected that the courts would follow the regulations, rather than the law itself? Precedents say not. Courts are supposed to interpret laws. In the case of the excess profits tax, however, there is a strong chance that the courts will follow the Commissioner's lead as to the mysterious Section 210, and from there to the regulations, and thus will protect and confirm every taxpayer's right to relief as set forth in the regulations.

The 1918 law has removed part of the differential in favor of the overcapitalized corporation, but there will always remain many isolated inequalities which no law, general in its application, can avoid.

Method of invoking relief sections.-It cannot be expected that taxpayers will be permitted to file returns in which the relief which is claimed is reflected. While as a matter of right taxpayers can take advantage of the provisions of the law which extend relief under certain conditions, the determination of the measure of relief is specifically left to the Commissioner. Therefore returns in the first instance must accord as nearly as possible with the sections of the law which deal with usual cases, and the taxpayer must await the action of the Advisory Board and the Commissioner before definite assurance can be obtained that the final amount of tax to be paid will be no more than the taxpayer believes to be correct.

To some extent, however, the taxpayer is relieved from being required to pay the full amount of the tax which would have to be paid if his return were prepared without the benefit of the relief sections. The law provides that if the tax is computed without taking into consideration the relief sections and it amounts to more than 50 per cent of the net income of the taxpayer, no greater tax need be paid than 50 per cent unless and until the claim for relief is heard and determined. This