CHAPTER XXXVII

FEDERAL CAPITAL STOCK (EXCISE) TAX

As a means of raising additional revenue, Congress in 1916 imposed an excise tax commencing in January, 1917,1 on corporations for the privilege of doing business. The rate ($1 per annum for each full $1,000) is comparatively low and the exemption ($5,000) such that the total tax is not excessive; but in view of the income and excess profits taxes imposed upon corporations this tax should have been discontinued. The early administration of this law did not reflect credit on the Department.

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The tax is due in advance. The next return will be due in July, 1919, and will be for the government's fiscal year July 1, 1919, to June 30, 1920.*

Theoretically, the tax is on the property of corporations, that is, on book value as distinguished from earning value, but it is difficult to assess a tax on the "fair" value of capital stock without considering its past earnings, so that in this respect the tax amounts to a duplication of the income tax.

When the law was enacted all the arguments as to the difficulty of administering a property tax were ignored. The injustice of placing a burden upon an unprofitable business was brushed aside. The tax does not apply to individuals and part

'Title 4 of the revenue act of September 8, 1916, Public No. 271, 64th Congress.

The former rate was 50 cents for each $1,000 and the exemption was $99,000.

"The time for filing 1918 returns was extended from July 31 to September 30, 1918, because the forms and revised regulations were delayed in issue.

"The following provision is made on form 707 for a corporation's fiscal year which ends at some date other than June 30: "In item 6 on page hereof the taxpayer will show the closing date of its fiscal year ended between July 1, 1917, and June 30, 1918, if other than June 30, and the information furnished under exhibits A, B and C will be as of the year or years ended on such date."

nerships. It is somewhat similar to various state laws imposing what are known as taxes on "corporate excess." Tax commissions have frequently commented on this system of taxation as having caused much difficulty, and litigation has been irequent. Market value is never taken as conclusive, because the courts will permit a taxpayer to point out any unfairness in an assessment based thereon. Earning power is never taken as the sole factor of valuation because earnings fluctuate too greatly. All the corporations (educational, fraternal, etc.) exempt under the income tax law are also exempt from this tax. In addition, many corporations organized for profit but not "doing business,” as interpreted by the Supreme Court of the United States, are also exempt. This applies to lessor, inactive and similar corporations.

The law [Section 1000 (a-1)] provides that the computation of the tax shall be based on "the fair average value of its capital stock for the preceding year." Therefore, the return due in July, 1919, will be based on the average value, etc., during the year July 1, 1918, to June 30, 1919, that being the government's fiscal year.

The Treasury has issued regulations1 which are reproduced in the following pages, governing the preparation of returns,

[Former Procedure] Regulations No. 38 were issued October 19, 1916. Regulations No. 38 (revised) were issued August 9, 1918. In the opinion of the author the requirements of the 1916 regulations were reasonable but T. D. 2503 (June 25, 1917) imposed new methods of ascertaining the "fair value" of the corporate stock which were fallacious, not in accord with the law and unenforcible.

As the valuation of capital stock is the basis for the assessment of the tax, the importance of a correct formula for calculating "fair value" should not be underestimated. Detailed criticism of the regulations will be found in 1918 Income Tax Procedure, pages 628 to 677.

Regulations No. 38 (revised, 1918) do not continue the former objectionable instructions. Therefore, it is considered unnecessary to repeat in this book most of the comments on the original regulations. But taxpayers whose returns for the fiscal year ended June 30, 1918, and earlier periods have not been examined or finally settled should refer to the 1918 edition of this manual.

From information which has come to the author it seems that very many close corporations were over-assessed, but that practically no corporation whose stock was listed on an exchange was so treated. The corporations which were over-assessed should apply for a refund.

etc. The law is wisely silent as to many details which usually encumber tax bills.

For convenience the text of the law and of Regulations No. 38 will be reproduced herein.

Domestic Corporations

Taxable period.-.

LAW. Section 1000. (a) That on and after July 1, 1918, in lieu of the tax imposed by the first subdivision of section 407 of the Revenue Act of 1916— ..

REGULATION. The tax became effective January 1, 1917, and is to be paid annually in advance for each year beginning July 1, except as to the first payment for the six months ending June 30, 1917. Special taxes, of which this is one, become due on the 1st day of July in each year, or on commencing any trade or business on which such tax is imposed. In the former case the tax is reckoned for one year, and in the latter case it is reckoned proportionately, from the first day of the month in which the liability to a special tax commenced to the 1st day of July following.' But see Article 11. No tax is refundable if a corporation ceases to do business during the year. (Art. 1.)

REGULATION. The tax applies to every corporation, joint-stock company or association (except insurance companies), now or hereafter organized in the United States for profit and having a capital stock represented by shares, irrespective of whether it is the creature of statute or of contract. A corporation is organized for profit if its stockholders or members may benefit pecuniarily from its opera

'Corporations whose fiscal years end at dates other than June 30 may submit figures based on their own fiscal years. (Instructions 2, form 707.)

"All special taxes shall become due on the 1st day of July, 1891, and on the 1st day of July in each year thereafter, or on commencing any trade or business on which such tax is imposed. In the former case the tax shall be reckoned for one year, and in the latter case it shall be reckoned proportionately from the 1st day of the month in which the liability to a special tax commenced to the 1st day of July following." (Section 3237, Revised Statutes, as amended by Section 53 of the act of October 1, 1890 [26 Stats., 567].)

tions. Joint-stock associations not organized under any statute and so-called Massachusetts trusts are subject to the tax.' Limited partnerships of the New York type, having practically no characteristics of a corporation or joint-stock company except limited liability as to some of the partners, are not within the scope of the tax, but Pennsylvania partnerships with limited liability and similar so-called limited partnerships or partnership associations, having perpetual succession and capable of taking title to real estate and suing in the common name, are subject to the tax, although they may not issue stock certificates to evidence the shares of the members. (Art. 2.)

SUBSIDIARY CORPORATIONS.—

REGULATION. So-called subsidiary corporations, all or a part of the stock of which is owned by another corporation, must render returns in the same way as other corporations. No deduction is allowed in the return of a holding corporation for the tax paid by a subsidiary. (Art. 24.)

Subsidiary corporations, even though their stocks are not listed, have been granted the privilege of placing a "fair" value on their stocks by using as a basis the market value of the shares of their holding companies. (T. D. 2493 [May 22, 1917] T. D. 2509 [July 7, 1917].) For suggested form of return see 1918 Income Tax Procedure, pages 659-661.

LAW. Section 1000. (c) . . . The taxes imposed by this section shall apply to mutual insurance companies,

INSURANCE COMPANIES.—

REGULATION. The tax also applies to insurance companies which are organized under a statute or derive from that source some quality or benefit not existing at the common law, irrespective of whether or not they are organized for profit or have a capital stock represented by shares. Mutual and participating plan companies are included. A mutual protective association organized under a statute, whose only source of revenue is the assessments paid by its members and whose net income for each year is paid into a reserve fund, constituting the sole resource of the company, aside from current assessments, for the payment of losses, is an insurance company within the meaning of the statute. (Art. 3.)

"Massachusetts trusts" were held to be exempt from the excise tax in Eliot v. Freeman et al., 220 U. S. 178 (T. D. 1686), and corporations in hands of a receiver are exempt. (T. D. 2424.) In Malley v. Crocker (U. S. Circuit Court of Appeals, Mass., May 3, 1918), Massachusetts trusts were held to be "associations."

Basis of liability to tax.

LAW. Section 1000.

(a) . . . . (1) . . . . shall pay annually a special excise tax with respect to carrying on or doing busi

ness,

REGULATIONS. The tax is imposed "with respect to the carrying on or doing business" by a corporation. It may be described generally as a tax upon the doing of business in the capacity of corporation, joint-stock company, or insurance company. "Business" is a very comprehensive term and embraces everything about which a person can be employed. Every corporation that is doing business, and no corporation that is not carrying on or doing business, is subject to the tax. As corporations are organized to do business, every existing corporation will be presumed to be subject to the tax unless it submits proof satisfactory to the Commissioner of Internal Revenue that it is not doing business. The distinction is between the mere ownership of property and the actual doing of business in the capacity above designated. The fair test is whether a corporation has reduced its activities to the owning and holding of property and the distribution of its avails and doing only the acts necessary to continue that status, or is still active and is maintaining its organization for the purpose of continued efforts in the pursuit of profit and gain and such activities as are essential to those purposes. (Art. 4.)

"DOING BUSINESS" ILLUSTRATED.—

Corporations organized for the purpose of doing business and actually engaged in such activities as buying timber lands and other real estate, leasing property, collecting rents, managing office buildings, making investments of profits, or leasing ore lands and collecting royalties, managing wharves, dividing profits and in some cases investing the surplus, are engaged in business within the meaning of the statute. A corporation engaged in mining, or in owning, developing, and speculating in mineral lands, is doing business. A corporation formed to take over miscellaneous stocks, bonds, and other property, to negotiate the sale of the various items from time to time as opportunity and judgment dictate, and to distribute the proceeds from time to time as liquidation is effected, is organized for profit and while engaged in such liquidation is carrying on business.' (Art. 5.)

NOT "DOING BUSINESS."

On the other hand, a corporation which has discontinued active operations and whose sole purpose and activity is limited to holding

'For court decisions bearing on liability and non-liability to tax, see 1918 Income Tax Procedure, pages 654-659