again in 1926, to all affiliated corporations and the election is supposed to be made on the filing of these returns. The reason for the two elections is that subdivisions (c) and (d) provide different measures for affiliation as between 1925 and subsequent years. It might be urged that when the corporate relationships are not affected by the differing definitions of affiliation, the option exercised for 1925 will be binding thereafter. However, the regulations seem to have placed a broad and reasonable interpretation upon the law.

Once made, the election for 1926 is held to be binding, unless permission to change is secured from the Commissioner. Consequently, the only affiliated corporations which may thereafter exercise the option without special permission from the Commissioner are those which, because they have become newly affiliated, have not theretofore had an opportunity to choose.

WHAT CONSTITUTES AN EXERCISE OF THE ELECTION?-Several rulings have been published, under the similar election extended by the 1921 law, which throw light upon the Treasury's position with reference to the exercise of the election. Thus a corporation which secured the control of another corporation for a negligible part of the year 1922 and did not file a consolidated return, was nevertheless permitted to file a consolidated return for 1923, the action in filing separate returns in 1922 not being considered an exercise of the election. (C. B. II-2, 216; I. T. 1783.)

On the other hand, when two affiliated corporations filed a consolidated return for 1922 upon the advice of an accountant, the corporate officers themselves being at the time unfamiliar with the provisions of the act, they were refused permission to file separate amended returns for 1922 "although the consolidated return may have been made in ignorance of the election conferred." (C. B. II-2, 211; I. T. 1777.) The latter ruling is not consistent with the recognized principle of law that there can be no valid election when the one who exercises the option is in ignorance of the alternatives which must always exist when an election is had.2

Who may file consolidated returns?-In order to file consolidated returns, the corporations involved must first meet the requirements of affiliation set forth in the law.

"For further discussion of options, see Patent Depreciation, Income Tax Procedure, 1925, page 1135 et seq.

"AFFILIATED CORPORATION" DEFINED.3.

LAW. Section 240. ... (c) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the voting stock of the other or others, or (2) if at least 95 per centum of the voting stock of two or more corporations is owned by the same interests. This subdivision shall be applicable to the determination of affiliation for the taxable year 1925.*

(d) For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns at least 95 per centum of the stock of the other or others, or (2) if at least 95 per centum of the stock of two or more corporations is owned by the same interests. As used in this subdivision the term "stock" does not include nonvoting stock which is limited and preferred as to dividends. This subdivision shall be applicable to the determination of affiliation for the taxable year 1926 and each taxable year thereafter.

Subdivision (c) is applicable only to the year 1925 and repeats the definition of affiliation laid down in the 1924 law. Subdivision (d) relates to 1926 and subsequent years. The distinction lies in the fact that for 1925 the sole factor to be considered was voting stock, whereas for subsequent years non-voting stock is also included, provided it is not limited and preferred as to dividends. Therefore, a fully participating nonvoting stock, which may or may not be preferred in liquidation, would rank with voting stock after 1925, but not for 1924 or 1925.

MEANING OF "THE SAME INTERESTS."

REGULATION.

The words "the same interests" shall be deemed to mean the same individual, partnership, or corporation, or the same individuals, partnerships, or corporations, but when the stock of two or more corporations is owned by two or more individuals, by two or more partnerships, or by two or more corporations, the corporations will not be held to be affiliated unless the percentage of stock of such corporations held by each individual, each partnership, or each corporation is substantially the same in each of the corporations. (Art. 633.)

FOREIGN CORPORATIONS EXCLUDED. The language of section 240 (c) and (d) of the law restricts the definition of affiliation to domestic corporations.

. Foreign corporations

REGULATION. may not file consolidated returns. A domestic corporation will not be permitted to include For law, regulations, rulings and decisions regarding affiliation under 1917, 1918 and 1921 laws, see Excess Profits Tax Procedure, 1926, Chapter 15. The 1924 law is identical with subdivision (c) above.

4

the net income of any such corporation in a consolidated return. (Art. 632.)

In a case under the 1918 law, where a New Jersey corporation owned all of the outstanding stock in a foreign corporation, which in turn owned all of the outstanding stock in a New York corporation, the Commissioner held that it would be necessary for the New Jersey corporation and the New York corporation to file a consolidated return, excluding the foreign corporation."

CORPORATIONS CLASSED UNDER SECTION 262 EXCLUDED.—

LAW. Section 240. ・ ・ ・ (g) For the purposes of this section a corporation entitled to the benefits of section 262 shall be treated as a foreign corporation.

Domestic corporations which derive the major portion of their income from sources within the territorial possessions of the United States cannot be included in a consolidated return, by the taxpayer. The possibility of consolidated accounts in such cases is discussed on page 104 et seq.

CORPORATIONS UNDER CHINA TRADE ACT, 1922, EXCLUDED.—

LAW. Section 240. (e) ... A corporation organized under the China Trade Act, 1922, shall not be deemed to be affiliated with any other corporation within the meaning of this section. . . .

If such corporations can meet the requirements of section 240 (d), the accounts may be consolidated. (See page 104.)

CORPORATIONS.-In

CONSOLIDATED RETURNS RESTRICTED ΤΟ theory, consolidated returns should be permitted whenever business relations are so close that a shifting of income or expenses could be resorted to in order to save or equalize tax or where an arbitrary division into separate entities of businesses conducted by the same interests might result in excessive taxes. However, as individuals and corporations are subject to different rates of tax, it is illegal to permit an individual trader, or a partnership, no matter how closely related to a corporation (even to the extent of 100 per cent joint

Letter to a subscriber of The Corporation Trust Company, signed by Acting Deputy Commissioner P. S. Talbert, and dated April 23, 1919.

[Former Procedure] See Income Tax Procedure, 1926, page 133. Former Procedure] Under the 1918 and 1921 laws partnerships becoming incorporated prior to July 1, 1919, or between January 1, 1921, and March 23, 1922, had the option of being taxed as corporations from January 1, 1918, or from January 1, 1921, and, if affiliated with a corporation, could be included in a consolidated return. There is no similar provision in the 1924 law.

ownership) to participate in filing a consolidated return. For the possibility of consolidating accounts see page 104 et seq.

CONSOLIDATED RETURN MUST INCLUDE ALL CORPORATIONS AFFILIATED. The question often arises as to whether two or more of the corporations in a group of corporations affiliated within the meaning of the law may file a consolidated return while other corporations in the group file individual returns. The Treasury holds that the privilege of filing a consolidated return is one which is extended to the group as a whole and that the alternative is for each corporation in the group to file an individual return. (C. B. IV-1, 238; S. M. 2683.)

CORPORATIONS IN HANDS OF RECEIVERS NOT EXCLUDED.

RULING. . . The basis of consolidation, therefore, for the years in question (1917, 1918, and 1919) is the ownership or control of the stock of the corporations. The appointment of a receiver for a corporation does not ordinarily change the control or ownership of the corporation's stock. While it may change the control of the corporation for the period of the receivership, the consolidation is not based upon control of the corporation but the ownership or control of the corporation's stock. Where the appointment of a receiver leaves the ownership and control of the corporation's stock in the parent company, the plain language of the Acts and regulations requires the subsidiary to be consolidated with the parent company and there is no authority for excluding it from the consolidation during the period of the receivership. . . . . (C. B. I-1, 296; A. R. R. 818.)

This ruling has added strength under the 1926 Act as control is no longer a factor. Stock ownership is what is now required.

RETURNS WHERE AFFILIATED STATUS HAS CHANGED.—

REGULATION. (a) Where corporations are affiliated at the beginning of a taxable year but due to a change in stock ownership during the year the affiliated status is terminated, or (b) where corporations are not affiliated at the beginning of the taxable year but through change of stock ownership during the year become affiliated, a full disclosure of the circumstances of such changes of stock ownership shall be submitted to the Commissioner.

Ordinarily in such cases, where only two corporations are involved, the parent or principal corporation, under the conditions described in (a) above, should file a consolidated return including the income of such subsidiary or subordinate corporation to the date of the change of stock ownership, and each should file a separate return from the date of such change in stock ownership to the end of the taxable period, and, under the conditions described in (b) above, each corporation should file a separate return from the beginning of the taxable period to the date of the change in stock ownership, and a consolidated return should be filed

by the parent or principal corporation from the date of change of stock ownership to the end of the taxable year, including therein the income of the subsidiary or subordinate corporation for such period.

Where there are more than two corporations affiliated at the beginning of the taxable year, and due to a change in stock ownership the affiliated status of one or more is terminated, but there remain at least two corporations affiliated during the entire year, the parent or principal corporation should file a consolidated return for the entire year, excluding from its return the income of the corporations whose affiliated status is terminated from the date of the change in stock ownership; or where two or more corporations are affiliated at the beginning of the taxable year, and through change in stock ownership additional corporations become affiliated, the parent or principal corporation should file a consolidated return and include the income of such corporations from the date of change of stock ownership. In either case, the subsidiary or subordinate corporation whose status is changed during the taxable year should make a separate return for that part of the taxable year during which it was outside of the affiliated group.

Where, in accordance with the procedure set forth above, a return is made by a corporation for a period less than a year, the tax shall be computed in accordance with sections 226 and 239 and the articles thereunder. Where corporations become affiliated during the taxable year the separate returns of the corporations for the portion of the taxable year during which they were not affiliated will not be due until the fifteenth day of the third month following the close of the taxable year. For example, if two corporations become affiliated on July 1, 1926, and elect to file a consolidated return for the period from July 1 to December 31, 1926, the separate returns of the corporations covering the period from January 1 to June 30, 1926, will be due on March 15, 1927. In any case in which the change of affiliated status is for a period so short as to be negligible, a consolidated return or separate returns for the entire period, as the case may be, may be filed; in such cases, however, there should accompany the return a complete statement setting forth the changes in the affiliated status occurring during the taxable year. (Art. 634.)

It may be necessary to file three or more returns for a single year in case of merger-one for each corporation before the merger, covering the portion of the year during which the corporations existed as separate entities, and one for the merged corporation after consolidation. The procedure to be followed under the various conditions which may exist is fully explained in article 634. The question whether the net loss of a corporation reorganized under section 203 may be carried forward by the new corporation is discussed in Chapter 34.

When is it advantageous to file consolidated returns?—If consolidated returns are made, intercompany transactions which involve profits or losses may be freely entered into without affecting