by law for filing the return, the corporation has distributed as a special dividend to or for the benefit of such persons as on the last day of the taxable year were resident in China, the United States, or possessions of the United States, or were individual citizens of the United States or China, and owned shares of stock of the corporation; (2) that such special dividend was in addition to all other amounts, payable or to be payable to such persons or for their benefit, by reason of their interest in the corporation; and

(3) that such distribution has been made to or for the benefit of such persons in proportion to the par value of the shares of stock of the corporation owned by each; except that if the corporation has more than one class of stock, the certificates shall contain a statement that the articles of incorporation provide a method for the apportionment of such special dividend among such persons, and that the amount certified has been distributed in accordance with the method so provided.

(c) For the purposes of this section shares of stock of a corporation shall be considered to be owned by the person in whom the equitable right to the income from such shares is in good faith vested.

(d) As used in this section the term "China" shall have the same meaning as when used in the China Trade Act, 1922.

Article 1143 defines "China" as meaning (1) China, including Manchuria, Thibet, Mongolia, and any territory leased by China to any foreign government, (2) the Crown Colony of Hongkong, and (3) the Province of Macao.

It is held that the latest permissible date for the declaration of the special dividends referred to above is March 15. (C. B. III-2, 249; I. T. 2120.)

Dividends received by residents of China from China Trade Act corporations are exempt from tax (see Chapter 26) and are therefore excluded from any returns filed by them. When received by others than residents of China, they are included in gross income; no credit for normal tax is allowed in respect of such dividends. (China Trade Act, 1922, section 27.)

REGULATION. The items of gross income to be included in the return of a corporation organized under the China Trade Act and the deductions allowable are the same as in the case of other domestic corporations. (Art. 1141.)

The tax rates established by the 1926 law were made effective from January 1, 1925.

Rates applicable to individuals.-The total tax on the income of individuals consists of two parts, the normal tax and the surtax. Effective January 1, 1925, normal tax is a flat rate of 5 per cent, but in the case of citizens 1 or residents of the United States the rate upon the first $4,000 subject to normal tax is 12 per cent and upon the next $4,000 is 3 per cent.2 Alien individuals who are residents of Canada or Mexico are taxed at the same rates as citizens or residents in so far as their income is derived from services rendered in the United States. The surtax begins to apply when the net income exceeds $10,000.

The rates are applied to "net income," which is ascertained by subtracting specified "deductions" from "gross income," the latter being defined in the law to include the distributive shares of the profits of partnerships. The terms "gross income" and "net income" are fully explained in Chapter 13.

For the purposes of the normal tax only, further deductions are permitted under the title of "credits." (See Chapter 6.) These credits consist of dividends, interest on certain securities, and the personal exemptions.

1 The taxation of non-resident citizens whose income is derived wholly from the ownership of property situated in a foreign country is constitutional. (Cook v. Tait, 286 Fed. 409, 265 U. S. 47.)

2 Citizens of the United States entitled to the benefits of section 262 (see Chapter 41) are subject to normal tax at the rate of 12 per cent on the first $4,000 of total net income from sources within the United States in excess of credits, 3 per cent on the next $4,000 and 5 per cent on the balance.

Normal tax.

....

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LAW. Section 210. (a). . . There shall be levied, collected, and paid for each taxable year upon the net income of every individual a normal tax of 5 per centum of the amount of the net income in excess of the credits provided in section 216, except that in the case of a citizen or resident of the United States the rate upon the first $4,000 of such excess amount shall be 11⁄2 per centum, and upon the next $4,000 of such excess amount shall be 3 per centum; . . . .

Surtax. The personal exemptions and other credits, such as dividends, are not recognized as deductions from the item of "net income" to which the surtax applies. (See Chapter 6.)

REGULATION. In addition to the normal tax imposed by section 210 (see articles 1-4) a surtax is imposed at the rates specified in section 211. upon the net income of every individual, resident or nonresident.

In determining the taxable net income, for the purpose of the surtax, the credits provided by section 216 in the case of the normal tax are not applicable..... (Art. 11.)

The rate which applies to each successive increment of income, the tax which results from the application of the rates to the increments, and the cumulative surtax, are set forth in the table on page 128.

The official directions for interpreting the table of surtax rates reads as follows:

REGULATION. . . . . The surtax for any amount of net income not shown in the table is computed by adding to the surtax for the largest amount shown which is less than the income, the surtax upon the excess over that amount at the rate indicated in the table. Accordingly, the surtax upon a net income of $63,128 would be $4,900.48, computed as follows:

1917.

1918.

1919-1923. 1924..

Earlier normal rates were as follows:

I per cent

2 per cent

4 per cent, but only 2 per cent on the first $2,000 12 per cent, but only 6 per cent on the first $4,000 8 per cent, but only 4 per cent on the first $4,000 6 per cent, but only 2 per cent on the first $4,000 and 4 per cent on the next $4,000

As to income of residents of Canada and Mexico arising from services performed in United States, see Chapter 41.

SURTAX RATES AND AMOUNTS OF SURTAX PAYABLE UNDER SCALE ESTABLISHED BY 1926 LAW"

Capital net gains and losses.-Gains from the sale or exchange of capital assets are taxed at a maximum rate of 122 per cent. Capital net losses must be segregated from ordinary net income and the reduction in tax is limited to a maximum of 122 per cent of such losses. (See Chapter 21.)

Surtax on sale of mineral deposits.

LAW. Section 211. . . (b) In the case of a bona fide sale of mines, oil or gas wells, or any interest therein, where the principal value of the property has been demonstrated by prospecting or exploration and discovery work done by the taxpayer, the portion of the tax imposed by this section attributable to such sale shall not exceed 16 per centum of the selling price of such property or interest.'

[Former Procedure] See Income Tax Procedure, 1926, page 166. To ascertain the total tax the normal tax of 12 per cent on the first $4,000. 3 per cent on the next $4,000 and 5 per cent on the balance, must be applied to the total net income minus the credits and the result added to the figure given in this table. The total tax must then be reduced by the earned income credit. See page 150.

[Former Procedure] This rate, for 1918-1921, was 20 per cent.

REGULATION. Where the taxpayer by prospecting and locating claims, or by exploring and discovering undeveloped claims, has demonstrated the principal value of mines, oil or gas wells, which prior to his efforts had a relatively minor value, the portion of the surtax attributable to a sale of such property or of the taxpayer's interest therein shall not exceed 16 per cent of the selling price. Exploration work alone without discovery is not sufficient to bring a case within this provision. (See article 220.) Shares of stock in a corporation owning mines, oil or gas wells, do not constitute an interest in such property. To determine the application of this provision to a particular case, the taxpayer should first compute the surtax in the ordinary way upon his net income, including his net income from any such sale. The proportion of the surtax, indicated by the ratio which the taxpayer's net income from the sale of the property, or his interest therein, bears to his total net income is the portion of the surtax attributable to such sale, and if it exceeds 16 per cent of the selling price of the property or interest, such portion of the surtax shall be reduced to that amount. (Art. 13.)

The Solicitor holds that explorations and discoveries made prior to March 1, 1913, are not within the meaning of Section 211 (b). (V-27-2817; S. M. 5723.)

The Commissioner's formula for applying the reduced rate was questioned in Fowler's Appeal (1 B. T. A. 1212). The Board upheld the Commissioner.

This provision of the regulations was also approved in Fowler v. U. S. [11 F. (2d) 895].

If the taxpayer has held the property for more than two years, he may elect to be taxed at a maximum rate of 122 per cent on the profit under the capital gains provision. (Section 208, see Chapter 21.)

RULING. Where individuals transfer property to a corporation which later demonstrates the principal value of such property as oil-producing property "by prospecting or exploration and discovery work" and then dissolves, transferring the property to the individuals, who remain stockholders without change in interests, and such stockholders sell the property, the portion of the surtax attributable to such sale is not limited to 20 per cent [1918 law] of the selling price of such property or interests under the provisions of section 211 (b). (C. B. 1, 57; T. B. R. 8.)

It is well to bear in mind that in computing the profit on the sale of oil wells the "discovery value" is not a factor. The "discovery" itself operates to give the seller the benefit of the 16 per cent tax but the "discovery value" is used only in computing the depletion allowance. Some confusion has arisen on this point in rulings handed.

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For definition of "discovery," see Chapter 38.

The limitation of 16 per cent provided by section 211 (b) is computed on the selling price of the property.