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To determine the amount subject to tax in the case of an appreciation of property a comparison must be made between the value as established at the beginning of the period, in accordance with the principles laid down in the preceding chapter, and the value at the end of the period as established by the price for which the property is sold or exchanged.

What Constitutes a Closed Transaction? When an outright sale is made for cash no problem exists; but transactions vary by imperceptible degrees from the outright sale for cash through various sorts of trades and exchanges to the transaction in which the property is too indefinitely valued to afford a basis for claiming that a "realization” has been made. It is here that serious problems of procedure arise. When is a sale a true sale in the sense of being a closed transaction rather than merely a continuing one?

The attempts of the Treasury to answer this question have been conspicuously unsuccessful and, as a result, great doubt exists in many cases as to whether taxable realizations have actually been made. There is perhaps no part of the entire field of income tax procedure in which the interpretation of the law is more vague and uncertain.

In these days when tax rates fluctuate violently from year to year, uniformity of treatment with respect to the taxation of realizations is highly important. The owners of two pieces of property appreciating in an identical manner over a period of years may have to pay radically different taxes, depending upon the particular years when realizations chance to occur. This difference may develop to such serious proportions as to justify an attempt to devise some method of inventory for such property which would result in an annual tax on the appreciation of each person's property at the same rates. Or it may lead to the system of taxation of gains which was adopted regarding dividends received in 1917, viz., the apportionment of part of the gain to previous years and the application of the tax rates in force in those years.

It may be necessary to apportion the gain ratably over the previous years and thus work certain inequities, but in most cases the proposed system would spread the surtax and thus remove the chief criticism of a tax law which imposes in one year a graduated tax upon a gain which may have been accruing since 1913. While the present situation continues, it would seem wise to avoid as many opportunities for injustice as possible by making sure that the tax is levied only in cases which are undeniably realizations.

Criticism of Treasury rulings. It is apparent that the Treasury in passing upon the question of what constitutes a closed transaction in cases of reorganization has pursued a course which is not only inconsistent but very far from conservative. “The equivalent of cash to the amount of its fair market value, if any," the phrase used by the new law, if interpreted in the light of certain regulations, would include within its scope cases in which the valuations would rest upon the flimsiest of foundations. Even where securities are actively dealt in on the exchanges the market values may be manipulated or temporary. To avoid injustice the tax should be levied only on those persons who actually realize on their securities. Those who hold and sell later should not be penalized. If they sell later at the market prices prevailing at the time of reorganization, the same tax will be paid-unless. there is a change in the rate, and in that case the chances of its being substantially lower are not bright. If a greater profit is realized, a greater tax will be paid, and if a smaller profit is realized, a smaller tax will be paid; but this is as it should

be and as the law intends. Not until the moment of an actual realization can an investor know the true outcome of the transaction. Up to that point no real gain, profit or income has accrued. Herein lies the chief difficulty in applying the inventory method to capital assets, because all inventory values are based upon estimates.

The Treasury differs from most of the courts in its interpretation of the words "gains, profits and income.” These words as they appear in the law should be construed in their usual meaning. The exchange of one security for another in itself cannot possibly constitute a gain or a profit or an income, unless and until there is some proof of a gain or profit.

The following case indicates the judgment of the United States Circuit Court of Appeals for the Eighth Circuit:

Decision. Here, then, were the promoters of a new mining corporation, fixing values at which one set of parties would exchange their individual stocks in several corporations for $21,000,000 of stock in the new corporation, and the values at which their new corporation would exchange its 10-year bonds to the amount of $4,299,000 for the securities of another party. Undoubtedly, they might have found and agreed what the market values of all these securities were on a sale for cash, and they might have contracted that these securities should be deemed of the values which they stipulated in all controversies that should subsequently arise under the agreement. But casual expressions and loose recitals cannot be permitted to establish such a contract. Nothing short of a plain stipulation to that effect ought to be permitted to prove it, in view of the fact that the determination of actual values was not necessary to the completion of the pending negotiations. ....

The evidence convinces us that their minds never considered or met upon the question of the actual market value of any of these securities, and that they never intended to, and never did, make any binding agreement upon that subject. The defendant, therefore, did not contract that the market value of the plaintiff's stocks was $1,483,816 in cash, or in anything but the stock of the Consolidated Mines at 50 per cent of its par value. ....

The difficulty with the rule applied by the court to measure the damages in this case seems to be its failure to note the difference between the actual value of the plaintiff's stocks and the value at which they were estimated in the contract for the exchange of securities. In a simple transaction this difference seems clear and radical. (Rockefeller v. Merritt, 76 Fed. 909.)

It might be urged that if a taxpayer were permitted to continue to exchange or trade securities without being required to report such transactions for income tax, he might in the course of time run up a “shoe-string" to a million dollars without having paid a cent of tax thereon. This is, of course, true, but such a person would be in no more favorable a position than the person whose property appreciates to a like degree without being exchanged back and forth from hand to hand. The truth is that there is no logical stopping point between the policy of taxing no capital gains at all and the policy of taxing everyone's capital gains periodically upon the basis of an inventory. The present law essays a compromise and attempts to tax gains when the property exchanged has a “fair market value.” The author's contention is that this value should be something more definite than a guess or even a value imputed from an occasional market quotation for similar property. The tax should rest upon a substantial foundation.

When sales are made for cash or equivalent.-As heretofore stated, little difficulty arises when there is an outright disposition of property. When a sale is made a taxable profit arises if the proceeds are greater than cost or market value, March 1, 1913. There is a further condition which is that the proceeds must consist of cash or the equivalent of cash. A great deal could be written on this subject, but the whole problem may be readily solved. If the securities or other property received consist of marketable securities, such as Liberty bonds, corporation bonds or stocks in which there is free trading in large lots on the New York or other prominent exchanges, no reasonable man can have difficulty in deciding on the exact value of the property received and reducing it to a cash basis.

If the property received consists of unlisted stocks or bonds or real estate there would be greater difficulty, but in the majority of cases the vendor has definitely determined the value of the property to be received. He has placed a sales value on the property disposed of even though such value was not disclosed to the other party to the transaction, and it may be assumed that the evidence on hand is sufficient to ascertain what may be regarded in his income tax return as the equivalent of cash.

We are, of course, assuming that the property received is different from the property disposed of not only in form but in substance. The exchange of real or personal property for shares of stock of a corporation which acquires such real or personal property usually is not a change in substance, but is merely a change in form.

If, however, the real or personal property turned into the corporation forms an inconsiderable part of its assets there is a change in substance, and it may be assumed that the taxpayer would not part with his real or personal property unless he deemed the shares of stock accruing to him as the equivalent of cash.

But when the property disposed of and the property received are both of unknown value, then from the point of view of realization the transaction cannot fairly be deemed to be a closed one. The taxpayer might find himself in the embarrassing position of not being able to dispose of any part of the property received and thus be without funds to pay the tax assessed.

It might be urged that the same situation would exist in some of the cases enumerated above where the recipient had determined the cash value, but where there was no ready market in which to dispose of the property received. This argument is well founded when the taxpayer's financial position is such that he has no available funds with which to pay the tax, but when a sale is made by a taxpayer who has funds with which to pay the tax it may be reasonable enough to assess it.

The foregoing is inconsistent and is merely presented for

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