wise), if not a transferee for a valuable consideration," are not to be included in the beneficiary's gross income. . . . . (Art. 541.)

....

INCOME FROM INSTALLMENT PROCEEDS OF "BUSINESS" LIFE INSURANCE.

RULING. The option exercised by a corporation beneficiary in allowing the proceeds of an insurance policy to be paid in installments represents in fact an investment of such proceeds. Any interest or profits received over and above the face value of each installment represents taxable income to the corporation for the year in which received. (C. B. I, 211; O. D. 66.)

Reserve fund to carry own insurance.-Premiums collected from customers and placed in a reserve fund by an automobile dealer to provide for losses through confiscation, under the Volstead Act, or through embezzlement, of automobiles sold by him on term contracts, are income in the taxable year in which they are received or accrued. (C. B. 5, 83; O. D. 1106.)

Of course payments made or liabilities contracted in respect of such premiums are allowable deductions.

Purchase by corporation of its own bonds at a discount.— When a corporation purchases its own bonds at a discount it is clear that the retirement of the bonds discharges a liability at less than book value, with a resulting credit to surplus. (See Art. 545.)

The conditions precedent are purchase and retirement. A corporation which buys some of its bonds in the open market at less than par and carries them at cost as marketable investments and has no intention of retiring them cannot be held to have realized a profit. The burden of proof is on the corporation to show that the bonds were not retired. If the bonds were resold at a profit, it would be taxable; if resold at a loss, it would be deductible.

Even if the bonds purchased at less than par are retired the courts may hold that no taxable income has been realized. At least that is a fair inference from the decision in Kerbaugh-Empire Co. v. Bowers.13 The Treasury, however, takes the contrary view. (Art. 545.)

In Independent Brewing Co. of Pittsburgh's Appeal (4 B. T. A.

13

12 This phrase was first introduced in Regulations 69. (See Chapter 12.) 300 Fed. 938; affirmed, 70 L. Ed. 518 (Adv. Op.), quoted and discussed on page 327.

870), the taxpayer in order to support the market price purchased some of its own bonds at a large discount, and sold some of them to the trustees for its sinking fund at par. The bonds were not retired. The Commissioner held that the discount was taxable income and was overruled. The Board said:

DECISION. In our opinion the taxpayer derived no taxable income from the purchase of its own bonds at less than the issue price. Certainly the transaction was not analogous to a short sale. The facts are simply that during the taxable year the taxpayer used a portion of its cash on hand to pay a portion of its debts. Whether it will ever be able to pay the balance of them is uncertain. We think that the principle laid down by the court in Bowers v. Kerbaugh-Empire Co. is controlling here. [300 Fed. 938; affirmed, 70 L. Ed. 518 (Ad. Op.).]

It has been held that taxpayers' own obligations in the form of corporate bonds are not susceptible of valuation at March 1, 1913, as is contemplated by the law for the purposes of establishing gain or loss from sale, exchange or ownership of property. (C. B. 5, 211; A. R. R. 545.)

Profit on purchase by corporation of its own stock not taxable.-Corporations sometimes purchase their own stock at a price less than par value. If the stock is retired or if it is carried as an asset on the corporation's books at par, the difference between par value and cost should be credited to surplus account. On this point the regulations provide as follows:

REGULATION. .... If, for the purpose of enabling a corporation to secure working capital or for any other purpose, the shareholders donate or return to the corporation to be resold by it certain shares of stock of the company previously issued to them, or if the corporation purchases any of its stock and holds it as treasury stock, the sale of such stock will be considered a capital transaction and the proceeds of such sale will be treated as capital and will not constitute income of the corporation. A corporation realizes no gain or loss from the purchase or sale of its own stock. . . . . (Art. 543.) ·

For practical purposes the regulation is sound. In some cases the resale of treasury stock is no different from the sale of other stock. In Cooperative Furniture Co.'s Appeal (2 B. T. A. 165) the taxpayer purchased some of its own stock in 1915 and in 1919 sold it at less than cost. The Commissioner disallowed the deduction and was upheld by the Board. The stock apparently was sold at much less than its fair value but the point was not discussed.

TREASURY STOCK-ACCOUNTING PROCEDURE.-In most states, if stock is issued for less than its par value, the subscriber is liable to creditors for the difference in the event the corporation becomes insolvent. In the absence of fraud, however, the judgment of directors as to the value of property or services paid in for stock is usually final. It frequently happens, therefore, that stock is issued for property or services, the actual value of which is less than the par of the stock. A part of this stock is "donated" to the corporation and become "treasury stock." A corporation may ordinarily sell "treasury stock" for any consideration it sees fit regardless of the par value. Of course any amounts realized from the sale of such stock are capital, but care should be taken not to treat such receipts as income on the books of the corporation. Courts should not be asked to treat as capital what the taxpayer itself has denominated income. Accounting practice is as follows:

If purchased by the corporation for resale, cost price is the correct basis of book entry; if purchased without specific intention to resell and more than par is paid, the premium should be charged to surplus. In effect, part of the surplus is paid to the retiring stockholder. The par value of the stock purchased should be deducted on the balance sheet from the total stock issued. When the cost is less than par, the purchase price should be carried in the books and in the balance sheet as an asset, but the item must not be included among any other assets. It is desirable that the number of shares should be stated. It is information which should be revealed. Many published balance sheets do show all details, but the practice is not uniform.

If acquired by gift, opinions differ as to the form of entry. Because of the legal formalities required to show that the stock has been issued full-paid, the best authorities sanction the setting up of the stock as an asset at par value, offsetting this entry by the creation of a reserve or surplus account which is designated as a capital item, and which is clearly differentiated from the surplus which arises out of profits or which is available for dividends. It is never proper to include any part of the book value of treasury stock among the current profits or as a part of the surplus available for dividends. This does not apply, however, if stock had been resold at a profit and the profit is realized in cash. As treasury stock is sold or otherwise disposed of, the asset account is credited and an adjustment is made between this account and the reserve or surplus account for the difference between the book value and the proceeds of the sale."

Gain or loss on sale of stock or dissolution of subsidiary.The Treasury has ruled that stock of a subsidiary corporation held by a parent company, or stock of a parent company held by a

"Auditing, Theory and Practice, Vol. I (1921 edition), by R. H. Montgomery, pages 206-207.

subsidiary, is not in effect treasury stock and gain or loss may be realized upon the sale of such stock, or on the dissolution of the subsidiary. (C. B. III-2, 244; S. 2205; C. B. I-1, 18; Sol. Op. 131; C. B. III-2, 256; A. R. R. 8159.)

However, in U. S. Trust Co.'s Appeal (1 B. T. A. 901) the Board held that a loss could not be claimed as a result of the dissolution of a wholly owned subsidiary. In the opinion of the author, the Board's decision is erroneous and the position of the Treasury correct.

For a discussion of the basis for determining gain or loss in such cases, see A. R. R. 8159, Chapter 18.

Forfeited stock subscriptions.-The Treasury holds that if the contract between a corporation and its stockholders provides that the amount paid in be forfeited if the subscription agreement be not completed, then the amounts so realized are taxable to the corporation, provided that such a contract is legal under the appropriate state laws.15

The foregoing ruling may be good accounting practice but if such receipts are not statutory income they cannot be taxed. The Treasury holds that the proceeds of sale of Treasury stock donated to a corporation do not constitute taxable income. (See page 331.) Why then should the proceeds of sale of original stock be held to be taxable income?

In Illinois Rural Credit Association's Appeal (3 B. T. A. 1178) the Commissioner held that forfeited subscriptions were income and was overruled by the Board which said:

DECISION. The payments on account of the stock subscriptions, at the time they were made, were undoubtedly capital payments, being made to provide capital for the corporation, and were in its hands capital receipts as distinguished from income. The fact that payments were made in installments and stock was never issued for such payments, because they were not made to the full amount of the subscriptions, does not alter their character.

Annuities, proceeds in excess of payments.—When an individual or corporation receives property against which annuities are chargeable the principal becomes a trust fund and must be treated as a liability. Payments to annuitants are charged against the capital fund and if in excess of the principal are deductible as losses. When the annuity payments cease the balance of the fund remaining,

" Letter to Anthony Becker, signed by Commissioner David H. Blair, dated April 9, 1923.

if any, becomes realized profit, and is taxable as income in the year when the liability ceases.

The Treasury treats the income from the property as taxable, and the payments to annuitants as capital expenditures. See Chapters 23 and 31.

Cash discount on capital expenditures not taxable.-The Treasury has held that a discount in consideration of prompt payment for equipment is not income, but that the cost of the equipment as charged to capital must represent only the net cost after making allowance for the discount.16

This ruling is in accord with what the author believes to be good accounting practice,17 but opinion on the point is divided.

Foreign exchange.—

RATE OF EXCHANGE ON INCOME ACCRUING ABROAD.18-In cases where accounts are kept in terms of foreign currency, current assets and liabilities should be converted at the current rate of exchange prevailing at the close of each taxable year. (C. B. 2, 60; O. D. 419.) If a branch office in a foreign country keeps its books in terms of foreign currency, making periodical remittances to the home office, its net profits for the year should be computed in the foreign currency. Any remittances should be converted at the rate of exchange current at the time the remittance is made. The excess of net profits of the branch over remittances made during the year should be converted at the rate of exchange prevailing at the end of the year. (C. B. 2, 61; O. D. 550.) (See also C. B. 5, 66; O. D. 1066.)

LIQUIDATION OF INDEBTEDNESS.-The Treasury has evolved a different procedure in cases involving the liquidation of liabilities to foreign creditors which appear on the books in the United States, and where remittances are made, not to cover specific invoices, but in a running account which remains open at the end of the year.

The rule laid down requires the averaging of the rate of exchange over the period, instead of applying specific rates to specific trans

10 Letter to E. G. Shorrock & Co., Seattle, Washington, signed by Deputy Commissioner L. F. Speer, and dated November 26, 1918, quoted in Income Tax Procedure, 1926, page 693.

Auditing, Theory and Practice, Vol. I (1921 edition), by R. H. Montgomery, page 587.

18 [Former Procedure] For practice during abnormal war conditions, see C. B. 2, 60; A. R. R. 15; Income Tax Procedure, 1926, page 693.