actions or inventorying at the close of the period. (C. B. 3, 75;

O. D. 590.)

The Treasury's position in regard to foreign items is not entirely clear but the rulings indicate that no attempt will be made to enforce arbitrary or unfair rules.

In Roessel & Co.'s Appeal [2 B. T. A. 1141 (A)] the taxpayer, a foreign corporation doing business in the U. S., deducted a loss on exchange incurred in the year 1918. The Commissioner disallowed the loss. The Board's opinion appears to sustain the Commissioner but is not clear.

CAPITAL ITEMS.-Fluctuations in exchange do not justify corresponding changes in the book values of capital assets or other than current liabilities. The expenditure by a corporation of a million dollars for a building in New York is unchanged on the books, except for depreciation or obsolescence, even though the apparent market value declines one-half. If one million dollars is expended for a building in Paris when francs cost 5 cents and francs happen to be 3 cents at the end of the year, the apparent decline of $400,000 is not an allowable deduction. Capital profits and losses must be realized before they affect income tax computations.

CURRENT ITEMS.-The author is of the opinion that current items abroad, such as accounts receivable and accounts payable, bank balances, etc., should be inventoried when the books are closed, as nearly as possible on the basis of cost or market, whichever is lower. (For further discussion as to inventory of foreign items, see pages 340 and 342.)

RULING. A corporation at the time of closing its books for the taxable year had an asset of pounds sterling represented by advances made in cash to its London representative for the purchase of raw material in the London market. The purchases had not been made at the time of the closing of the books.

The rate of exchange at the time of closing the books was lower than at the date the exchange was purchased.

Held, that the taxpayer did not sustain a loss as contemplated by the (C. B. 4, 64; O. D. 940.)

statute.

...

The item of "sterling owned" is a current asset. Under the ruling in C. B. 2, 61; O. D. 550 (see page 334), it should be inventoried at the rate of exchange in force at the end of the year.

It may not be a technical loss, but if allowed as an inventory loss the net result is the same.

When current assets abroad exceed current liabilities and exchange is lower at the end of the year than during the year, a loss will be shown. When exchange is higher, no profit or loss will be shown.

If foreign exchange has been purchased as an investment no profit can be taxed or loss deducted until there is a closed transaction; except, of course, in the case of dealers. But when foreign exchange has been purchased to use in connection with purchase of merchandise there is no more of an investment basis to be followed than if merchandise itself were acquired.

In Tiedemann's Appeal (1 B. T. A. 1077) the Board said:

DECISION. At November 30, 1919, the taxpayer had about 225,000 francs which had cost it seven francs to the dollar, and on which the value then was 10.15 cents per francs; likewise, it had 200,000 marks for which it had paid 42 cents and which were worth on November 30, 1919, 2/28 cents per mark. The shrinkage in the value of the foreign exchange was $13,750.67, which the taxpayer claims as a deduction from gross income on the ground that it was a loss sustained within the taxable year ended November 30, 1919.

What the taxpayer purchased was paper francs and marks-in other words, obligations of the issuing banks. The taxpayer was not a dealer in foreign exchange. The obligations did not constitute inventoriable items. They are not to be treated differently from any securities which might have been purchased by the taxpayer. If they had increased in value from the date of purchase to the close of the taxable year, such increase would not have constituted taxable income. Neither did the shrinkage in value constitute a sustained loss. No gain or loss from the transaction was realized during the taxable year ended November 30, 1919.

In the facts as found by the Board it is specifically stated that the francs and marks were purchased to pay for specific orders for goods previously placed in France and Germany. In the author's opinion the taxpayer had a legal right to inventory the exchange. Under good accounting practice failure to write the loss off as an expense would subject the offender to severe criticism from all credit grantors, including the Federal Reserve Board.

When current liabilities exceed current assets and exchange is lower at the end of the year than during the year no profit or loss will be shown. When exchange is higher a loss will be shown.

The rule is the same in case of one item of current asset or liability as it is in the case of branch houses.

The foregoing is merely conservative business practice and may or may not result in a saving of taxes. Based on market values, losses are taken, but profits are not anticipated.

In Bernuth Lembcke Co.'s Appeal [1 B. T. A. 1051 (A)] the taxpayer bought sterling exchange in January, 1920 and purchased goods with it in December, 1920. Sterling dropped from 3.864 to 3.50 in that time. The taxpayer claimed as a deduction the difference. The Commissioner disallowed it and was overruled by the Board which said:

DECISION. The cost of the creosote oil carried into the inventory at the close of the calendar year 1920 was not the amount that was paid for the exchange to carry out the contract made by the taxpayer with the Equitable Trust Company of New York, but $39,875 less than the amount paid for the exchange. The creosote oil could not be inventoried at December 31, 1920, at more than its actual cost and the cost was in terms of the exchange at the date of purchase. The contract for the purchase of the foreign exchange was entered into in the early part of 1920 and completed in the month of December, 1920, at a loss of $39,875. That loss is a legal deduction from the gross income of the taxpayer for the year 1920.

The Treasury has issued rulings summarizing the rates of exchange as of December 31, for each year from 1916 to 1925 inclusive. These rulings will be found in the bulletins as follows:

Income from Government Contracts

The law, regulations, rulings and comments on the 1918 and 1921 laws in respect to government contract income will be found in Income Tax Procedure, 1924, page 513 et seq. and 1926, page 697.

When a concern maintains a stock of any kind of property which is periodically renewed as it becomes exhausted, the proper procedure in determining profit or loss is to inventory such stock.

LAW. Section 205. Whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.

REGULATION. In order to reflect the net income correctly, inventories at the beginning and end of each year are necessary in every case in which the production, purchase, or sale of merchandise is an incomeproducing factor. .. (Art. 1611.)

...

The foregoing accords with good accounting practice.1 The keeping of accounts on a cash basis, ignoring inventories, should be discouraged. But the Commissioner cannot legally use unsound theories in building up inventories and assess additional taxes thereon. In Dixie Mfg. Co.'s Appeal [1 B. T. A. 641 (A)] the Commissioner properly attempted to verify the accuracy of returns filed on a cash basis. The revenue agent, however, constructed an inventory which to any intelligent person was absurd on its face. The taxpayer dealt in razors. By a process of stating purchases, sales, etc., the agent in four years arrived at a closing inventory of 106,000 razors. The same formula would soon have imputed an inventory of 1,000,000 razors. It is inconceivable why the taxpayer was compelled to appeal to the Tax Board.

In overruling the Commissioner, the Board said:

DECISION. An examination of the table showing the inventory computations made by the examining auditor is a conclusive demonstration of the danger of attempting to supply accounting facts from hypothetical computations. The accuracy of the examiner's inventory computations rests entirely upon an assumed ratio of gross sales and paid sales, constant for all years, an assumed ratio of returned razors to razors sent out, and an assumed ratio of razors returned in a damaged condition to total razors returned. . . . . It is inconceivable that the taxpayer would continue to order and pay for razors for use in its business if it had on hand usable or salable razors in the quantity set forth in the inventory presented by the examiner.

Nor are we convinced that the use of inventories in the taxpayer's case would result in more clearly reflecting the income than that income is reflected without the use of inventories.

Inventory must be taken as of one fixed date for entire business.

RULING. Taxpayers will not be permitted to adopt one period for inventorying and closing their books applicable to one part of their business and a different period applicable to another part thereof. (C. B. I, 62; O. D. 289.)

Taxpayers are of course permitted to adjust book inventories by physical count throughout the year, so as to avoid any considerable adjustments at the end of the year.

[Former Procedure] For a general discussion of the Treasury's position regarding inventories under all laws prior to 1926, see former editions of this book; also Inventories by H. B. Fernald, Proceedings, American_Mining Congress, 1923, and "Inventory Regulations and the Income Tax Law," by T. O. McGrath, in Proceedings, American Mining Congress, 1924.