are accrued. The law requires that accounts must be kept on a basis which clearly reflects the actual net income of the taxpayer. The accrual method has been prescribed as necessary to accomplish this result.

For manner of treating interest on bonds purchased and sold between interest dates, see page 425 for form given in this chapter for calculation of tax-exempt interest.

Of the aggregate of possibly exempt principal of $160,000 all but $5,000 represents temporary exemptions. The $45,000 and the two $30,000 exemptions under Second Liberty Bond Act will expire two years after the termination of the war with Germany, and the $30,000 exemption under the Victory Liberty Loan Act will expire five years after the termination of the war. The $20,000 exemption will expire when the Victory notes are paid. If the taxpayer is to secure over a period of years the maximum amount of exemption he must make his return of income on the accrual basis. Returns on the cash basis would not entitle the taxpayer to the exemption of interest received on these issues after the temporary exemptions expire.

Individuals

The foregoing portion of this chapter applies to individuals as well as to other taxpayers, but the following points. are applicable particularly to individuals.

Under the 1918 law individuals are taxed as such upon their income from partnerships in which they are members, from personal service corporations in which they are stockholders and from estates and trusts of which they are beneficiaries. It is necessary, therefore, for the individual receiving Liberty bond interest from a partnership, a personal service corporation or a fiduciary to group all such interest received by issues and to calculate his exempt interest on the basis of his combined holdings of principal as an indi

'See 1918 law, section 214 (a-2).

vidual, as a partner, as a stockholder in a personal service corporation and as a beneficiary of an estate or trust. The various regulations of the Treasury do not specifically describe the manner in which the principal of Liberty bonds held by partnerships, personal service corporations, estates and trusts shall be apportioned among the individuals receiving the income there from other than to say that each partner, etc., is to be regarded as owning a "proportionate part" of the bonds. The assignment of holdings, however, should ordinarily be made on the basis of the share in profits or income received from the partnership, corporation or fiduciary. In case of a net loss for the year by the partnership, personal service corporation or estate, although the individual will show his share of Liberty bond interest received from the partnership, personal service corporation or estate, any undue increase of taxable income of the individual thus apparently created will, in the case of partners and stockholders in personal service corporations, but not in the case of beneficiaries of trusts, be offset by the share of the loss of the partnership or personal service corporation which the individual will also show in his return.

The regulations covering exemptions of Liberty bond interest received from partnerships, personal service corporations and fiduciaries are contained in articles 81 and 82 which are in part as follows:

REGULATIONS. (a) When income is taxable to beneficiaries, as in the case of a trust the income of which is to be distributed to the beneficiaries periodically, each beneficiary is regarded as the owner of a proportionate part of the bonds held in trust and is entitled to exemption on account of such ownership as if he owned such proportionate part of the bonds directly. In such a case a subscription by a trustee for bonds of the Fourth Liberty Loan, or notes of the Victory Liberty Loan, constitutes each beneficiary existing at the time of such subscription an original subscriber for his proportionate part of such bonds or notes, as the case may be, and entitles such beneficiary to the appropriate collateral exemption of interest on

'See Chapter XXXIV.

bonds of previous issues, whether owned by such beneficiary or by the trustee, as if the beneficiary had himself originally subscribed for such proportionate part of the bonds or notes; and a subscription by such beneficiary for bonds of the Fourth Liberty Loan or notes of the Victory Liberty Loan, as the case may be entitles him to the appropriate collateral exemption of interest on bonds of previous issues held by the trustee. . . . (Art. 81.)

As income of a partnership is taxable to the individual partners, each partner is treated as the owner of a proportionate part of the bonds held by the partnership and is entitled to exemption on account of such ownership as if such partner owned such proportionate part of the bonds directly. Such partner, if a partner at the time of the original subscription by the partnership for bonds of the Fourth Liberty Loan or notes of the Victory Liberty Loan, as the case may be, is treated as an original subscriber for a proportionate part of such bonds or notes subscribed for by the partnership and is entitled to the appropriate collateral exemption of interest on bonds of previous issues on account of such original subscription for bonds or notes as if he had subscribed directly for such proportionate part. This principle also applies to stockholders in personal service corporations. (Art. 82.)

It is to be noted that to be deemed an original subscriber to bonds for purpose of claiming the conditional exemptions, the beneficiary of the trust, member of the partnership or stockholder of the personal service corporation, respectively, must have held such status at the time when the original subscription was made.

Partnerships

Since under the 1918 law partnerships are not taxable as such, the question of Liberty bond interest received by a partnership is really a question for the individual partner in his separate return-the partnership return merely indicates the share of each partner in the Liberty bond interest received by the partnership.10

10[Former Procedure] Under the 1917 law partnerships as such were subject to the excess profits tax. T. D. 2762, dated October 21, 1918, provides that in calculating Liberty bond interest received by a partnership, which may be subject to excess profits tax, the partnership shall be deemed to be the owner of the bonds upon which the interest is received.

Stockholders in Personal Service Corporations

The question of taxable interest received by personal service corporations affects the income of the stockholders, as they, not the corporation, are taxable on income received by or from it." The exemptions of such stockholders are determined in the same manner as members of a partnership. (See article 82, quoted above.)

Fiduciaries

Liberty bond interest received by executors, administrators, guardians, trustees and other fiduciaries is taxable to them only in case it is not distributable to the beneficiaries. of the estate or trust.1

12

If the fiduciary is liable to tax, he is entitled to the same exemptions of Liberty bond interest as those granted to an individual.

REGULATION.

When, on the other hand, income is taxable to the trustee, as in the case of a trust the income of which is accumulated for the benefit of unborn or unascertained persons, the trustee is regarded as the owner of all the bonds held in trust and the trust is entitled to exemption on account of such ownership. In such a case a subscription by a trustee constitutes the trustee as such the original subscriber and entitles the trust, on account of such subscription, to the collateral exemption of interest on bonds of previous issues. (Art. 81.)

Corporations

The general statements on pages 419 to 434 in this chapter apply to interest on Liberty bonds received by corporations other than personal service corporations.

Exemptions of affiliated corporations.-Under the ruling of the Treasury now in force, affiliated corporations are en

"See Chapter XXII.

"See Chapter XXXIV, "Fiduciaries," for discussion of the cases in which fiduciaries must make a return and pay a tax.

titled in the consolidated returns to the total of the exemptions under the various Liberty bond acts to which the several corporations would be entitled upon the bonds held by them if separate returns were made.

RULING. Reference is made to your letter dated April 22, 1919, in which you question the validity of a ruling in connection with exemptions to which several affiliated corporations included in a consolidated return are entitled on account of their ownership of various issues of Liberty bonds appearing in a letter from Acting Commissioner J. H. Callan dated April 16, 1919, to the Corporation Trust Company and printed in the War Tax Service, 1919, to the effect that:

"Whether each of the subsidiary companies owns the bonds or whether the parent company, or any one of the companies alone, owns the exempt bonds makes no difference in the amount of exemption allowable in cases where consolidated returns are required, as such exemptions are based upon the consolidated condition."

Upon further consideration this office rules that each of several affiliated corporations included in a consolidated return under section 240 of the Revenue Act of 1918 is entitled to the same full benefits under the exemption provisions of the several Liberty bond acts to which it would be entitled if not affiliated. (Letter, signed by Commissioner Daniel C. Roper, and dated May 21, 1919.) 13

Parent corporation may not apportion Liberty bonds held to its subsidiaries.-The Treasury has ruled that a parent corporation may not apportion Liberty bonds held by it among the affiliated corporations. The ruling, however, in so far as it would imply that the affiliated corporations would not have the benefit of all exemptions appropriate to bonds actually owned by the separate corporations is superseded by the ruling of May 21, 1919, quoted above.

[Former Procedure] A ruling to the contrary effect contained in a letter to the Corporation Trust Company, signed by Acting Commissioner J. H. Callan and dated April 16, 1919, was superseded by the letter of May 21, 1919, above quoted.