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an income tax return. In no sense of the word is such a payment capital. Although not an allowable deduction from net income, premiums on stock can only be paid from profits and that is the method always followed

Consequently the author cannot agree with the Treasury when it says that the payment of the premium in redeeming stock is “a capital transaction in which there can be no gain or loss to the corporation.” He does agree, however, with the conclusion that such payments are not deductible. As such payments are not allowable deductions to the corporation, and must, therefore, be charged direct to surplus, it can be claimed that a distribution of profits, equivalent to a dividend, has been made. The corporation will have paid the normal income tax thereon and should notify its stockholders of that fact so that they may enter the receipt of the premiums as a dividend and thus avoid the normal tax.

· Losses of Holding Companies Accounting

Procedure

The interests owned by holding companies in affiliated or subsidiary companies are usually represented by holdings of capital stock, bonds or other forms of indebtedness such as promissory notes, open book accounts, etc. When a holding company desires to reflect on its books the profits or losses of its subsidiaries, it does so by the accrual and reserve method,30 or by writing up or down the book valuations of the stocks or obligations owned.

Under existing rulings, a mere writing down of valuations is not an allowable deduction. But many transactions ordinarily reflected by a change in valuations are more properly recorded as “losses which are immediately deductible.” If a subsidiary loses money and the holding company advances funds, which in effect are used to make good the deficit, and

So Auditing, Theory and Practice (2nd edition), by R. H. Montgomery, page 514 et seq.

it is not likely that the subsidiary can repay the advance, it becomes a bad debt on the books of the holding company and should be charged off as a loss. Transactions of this kind are sometimes improperly handled. For example, the advance from the holding company to the subsidiary is often treated as a gift from one to the other. If this were really so, the holding company could not claim it as an allowable deduction (because gifts are not deductible); but in fact this is not a gift. It is on the part of the holding company one of the necessary expenses incurred in its business or a loss of similar nature. Holding companies are formed to make money. When they lose in transactions from which profits were expected to arise, it is a trade loss—not a gift in the nature of a beneficence or anything of that sort. Therefore at the time when such transactions are entered, the true state of affairs should be disclosed and inadvertent mention of a gift should be avoided. 31

The 1918 law provides for consolidated returns in all cases in which one corporation controls another or an individual controls two or more corporations. Therefore, when consolidated returns are made, the loss of one subsidiary operates as a credit against the profit of another and no adjustments need be made in the books.

But it would not be wise to depend on a continuance of the privilege of rendering consolidated returns. Representative Kitchin bitterly. opposed the provision.

Furthermore, state income tax returns will require accurate reports from subsidiaries and in many cases no report at all will be required from the parent company or an affiliated company.

"[Former Procedure) Article 115 of Regulations 33, 1918, required that earnings of subsidiaries taken up on the books of the holding company be returned as income. If the regulations were sound, then the converse must be good practice: that is, where losses of subsidiaries are taken up each month on the books of the holding company, they could be claimed as allowable deductions. As the author questioned the soundness of the ruling as it affects income, the same criticism applies where there is a loss.

Limitation nn losses incurred in transactions outside business or trade. Under the 1918 law all losses incurred in trade, or arising from transactions entered into for profit, are deductible, but under former laws there were limitations on the deductions.

For several years the author has contended that the Treasury did not properly interpret the earlier laws and that many losses which were disallowed were in fact allowable deductions. During 1919 a case was decided in a United States district court wherein the court held that the Treasury was in error in disallowing a loss which the taxpayer claimed as having been incurred in trade. The taxpayer received a large block of stock in an industrial company to whose affairs she evidently devoted some time and attention.

Decision. The transactions .... were complicated in character, involved a very large sum of money, and must have required much of her time and attention, and I am of the opinion that they were of the character contemplated by Congress as “incurred in trade.” [Bryce et al. v. Keith, Collector, 257 Fed. 133 (March 26, 1919).)

(Former Procedure]

The 1913 law merely allowed as a deduction losses "actually sustained during the year incurred in trade" and arising from certain casualties. No specific provision was included like that of 5 (a) fifth of the 1916 law, definitely permitting the limited deduction of losses in transactions, entered into for profit but outside one's business or trade, or definitely excluding them. Consequently the definition of the term "in trade" became of the very greatest importance and upon its interpretation rested the question whether or not the Treasury would recognize the entire deductibility of certain losses, because losses outside one's "trade" under this law might be construed to be not deductible at all (unless they were of the nature of the casualties described) whereas under the 1916 law they were deductible to the extent of gains from similar transactions.

At first the Treasury placed a liberal interpretation upon the phrase "losses incurred in trade," including, for example, transactions in securities by persons not dealers.

RULING. "If securities were purchased prior to March 1, 1913, and disposed of at a profit or loss during 1913, and no annual adjustment is made on the books, the profit or loss as ascertained when sold (that is, the difference between the cost and the selling price), shall be prorated and the proportionate profit or loss from March I would be gain or allowable deduction.

[Former Procedure-Continued]

"If the stock was purchased after March 1, 1913, and sold at a later date, during that year, the entire profit or loss in the transaction would be considered a gain or an allowable deduction in computing the net income." (Deputy Commissioner Speer, early in 1914.)

Moreover, this liberal interpretation appears to have been in conformity with the intention of the framers of the law. (See Congressional Record, April 26, 1913.)

This broad interpretation of the term was short-lived, however, for a Treasury decision issued June 2, 1914, took the following form:

REGULATION. “'In trade' is synonymous with business.
“ 'Business' has been defined as:

“'That which occupies and engages the time, attention and labor of anyone for the purpose of livelihood, profit or improvement; that which is his personal concern or interest; employment, regular occupation, but it is not necessary that it should be his sole occupation or employment.

“'The doing of a single act incidentally or of necessity not pertaining to the particular business of the person doing the same will not be considered engaging in or carrying on the business.'”

Still further restrictions were added a few months later, December 14, 1914.

REGULATION. ".... A person can be engaged in more than one business, but it must be clearly shown in such cases that he is actually a dealer, or trader, or manufacturer, or whatever the occupation may be, and is actually engaged in one or more lines of recognized businesses before losses can be claimed with respect to either or more than one line of business, and his status as such dealer must be clearly established." (T. D. 2090.)

In refusing to modify the foregoing decisions the Treasury position was made still more clear and definite.

RULING. "The act of Congress requires that the tax shall be paid upon the entire net income arising or accruing from all sources,' permitting the deduction of certain specified kinds of expenses and losses, one of which is 'losses actually sustained during the year, incurred in trade.' I have no authority to permit any other losses to be deducted than those which Congress provides for. If Congress had intended that all losses might be deducted, it would doubtless have so drafted the law. Therefore, forbidding the deduction from income tax returns of losses incurred outside the ordinary course of business, but requiring the inclusion of profits made outside the business, is not the act of the Treasury Department, but of Congress.” (Extract from letter to S. C. Mead, Secretary of the Merchants' Association of New York, signed by Secretary of the Treasury W. G. McAdoo and dated February 27, 1915.)

The attempt to apply the restriction as outlined above has involved many inconsistencies and injustices. Many taxpayers ignored the regulations and in their returns took credit for losses which no doubt will be disallowed. In such cases the tax should be paid under protest for there is at least a reasonable chance that it will be refunded some day.

The 1916 law [section 5 (a)] provided that in transactions entered into for profit but not connected with one's business or trade "the losses actually sustained therein during the year” were deductible only to an

[Former Procedure-Continued] amount not exceeding the profits arising therefrom. This, of course, was interpreted to permit gathering together in one sum the profits of all such transactions and in another sum all of the losses which are deductible to an amount not exceeding the sum of the profits. For example, if one dabbled in stocks and in real estate, both being outside one's "business or trade," losses in stock transactions needed not to be measured against gains from stocks alone in determining their deductibility, but could be measured against the total profits from both stock and real estate transactions.

Dividends received could not be designated as profits. The term "profits arising from transactions entered into for profit" might include dividends on stocks carried in a speculative account but would not include dividends received from investment stocks.

Definition of business or trade.--In imposing the above limitation the law burdened the taxpayer with the task of separating transactions connected with his business or trade from those which were not connected therewith. In making this classification he had as a guide the following regulation:

REGULATION. "The difference between losses . ... incurred in his business or trade' (4th deduction) and losses 'in transactions entered into for profit but not connected with his business or trade' (5th deduction), is illustrated by the difference between the definitions of 'avocation': That which takes one from his regular calling; a minor occupation; and 'vocation': The occupation or pursuit to which one devotes his time or life, a calling. It is possible for a man to give sufficient time, attention and capital to the pursuit of different lines of business to constitute more than one avenue of 'business or trade or employment,' his business or trade.

"Paragraph 4 of section 5 (a), act of September 8, 1916, provides for losses 'actually sustained during the year, incurred in his business or trade, etc.' These would be losses under the head of vocation.

“Paragraph 5 of section 5 (a), act of September 8, 1916, provides for losses actually sustained during the year in transactions entered into for profit but not connected with his business or trade; that is, losses under the head of 'avocation': that which takes one from his regular calling; a minor occupation. Losses under the head of 'avocation' may be deducted to an amount not exceeding the profits arising from transactions under this head.'” (Reg. 33, 1918, Art. 8.)

The Primer illustrates this distinction by the following example:

Ruling. “For example: 'A' is regularly engaged in buying improved or unimproved real property with the intention of selling the same as early as possible at a profit. In one or more instances the property purchased may be sold at a loss, and that loss may be claimed by him as a deduction under the provisions of the fourth paragraph for the reason that he is regularly engaged in buying and selling real estate. Now, 'B' buys a home or, perhaps, he buys two or three pieces of property in the course of several years. He is not regularly engaged in buying and selling real estate and, therefore, any loss he may suffer through such a transaction can only be claimed by him as a deduction under the provisions of the fifth paragraph of section 5; that is, only so much of his

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