corporation for the lease, the cost of the property of the corporation was the fair market value of the stock. This ruling is specifically limited to mining leases (L. O. 1033). Additional wells brought in on proven land already valued as of date of discovery or within 30 days thereafter do not change such value. Where one well proved a continuous area of land held by one lessee under a number of leases, it was considered the discovery well in connection with each and all leases. But where one well proved only a portion of a lease, it was necessary to bring in another well in the unvalued portion to value the entire lease (O. D. 527). Revaluation of a known mine was not permitted where improvements in treating ore had made ore formerly valueless, now of value (A. R. M. 124). March 1, 1913, valuations and subsequent valuations were allowed for depletion purposes on allotted and restricted patented United States property (L. O. 1098). Where no proprietary right was held in the land the lease cost or its fair value at March 1, 1913, was the only recoverable capital possible to the lessee through depletion (L. O. 1055). Before location could be made on a placer claim and prior to March 1, 1913, an executive order withdrew the right. Subsequently, the land was leased from the Government, and validated by the Leasing Act of February 25, 1920. The depletion deductible was based on March 1, 1913, values (L. O. 1110, overruling O. 118). The March 1, 1913, value to "innocent purchasers" of timber land in Federal litigation was determined by the value of the land at March 1, 1913, less the amount subsequently paid to the Government (Sol. Op. 124). Timber land acquired prior to March 1, 1913, should be divided into operating units to determine the basic values as of that date. A unit should be determined by the size of the average mill site (O. D. 43). The deduction for depletion based on the value at discovery or within 30 days thereafter, is allowed only to parties in possession at the time of discovery and not to subsequent purchasers (T. D. 3089). An unrestricted member of the Osage Indian tribe, as lessor, was allowed to deduct an allowance for depletion of the oil within the Osage Indian reservation according to his or her interest (I. T. 1478). In case a material error had been made in an estimate of the mineral content of a mine a new estimate could be made only by readjusting the rate of depletion on minerals subsequently extracted to the new estimate (A. R. R. 431, I. T. 1616). The value to the lessor of a lease on a coal mine was held to be the present worth of his royalties per ton. That is, the result obtained by multiplying the roy alty per ton by the number of estimated tons to be extracted by the lessee was taken at its discounted present value, which, when divided by the tons to be extracted by the lessee, gives the unit rate of depletion to the lessor (Sol. Op. 80). Where a company charged exploration expenses to capital for 1917, it could not later amend its returns (O. D. 796). If the option to charge developmental and drilling expenditures to operating expenses was exercised, such items could not subsequently be treated as capital expenditures (A. R. M. 110). Where the parent company exercised its option to charge developmental expense to operations, a subsidiary to whom the leases were sold was required to follow the same practice (O. D. 1002). In case a lease and the improvements thereon cost less than the value of the improvements, the lease was considered worthless and no depletion could be taken, because the capital could be restored by a return through depreciation charges on improvements (A. R. R. 570). To determine the depletion under the act of 1916 divide the entire fair market value at March 1, 1913, by the estimated content of the mine in tons and multiply the result so obtained by the number of tons so taken out each year (S. 1365). A fee owner was not permitted a deduction for depletion when minimum royalties were received but no ore extracted (A. R. R. 1147). Where a company contracted to convey to another company the merchantable lumber paid for and cut, it was held that the company purchasing the lumber acquired a lease rather than standing timber as a result of the sale. Accordingly, depletion could not be deducted (A. R. M. III). XIII INTEREST AND TAXES Interest on loans to purchase or to carry tax-free securities. Methods of computing non-taxable interest paid. Taxes. INTEREST, paid or accrued during the taxable year on any and all obligations of the taxpayer, is deductible. An exception is made to interest on loans to "purchase or carry" interest-bearing tax-free securities such as municipal bonds. Interest on loans to purchase or carry wholly tax-free obligations of the United States issued after September 24, 1917, is deductible, providing the taxpayer is an original subscriber. Hence, interest paid in connection with the First Loan (which was issued in the early part of 1917 and is entirely exempt from income taxes) is not deductible, while interest paid to purchase or carry holdings of all other issues excepting the Victory 334 Notes (also exempt but retired June 15, 1922) may be deducted whether or not the present holdings were originally subscribed for. A taxpayer must have been an original subscriber to the exempt Victory 334's which he still holds if interest paid in connection therewith is to be claimed as a deduction. In the 1918 act the deductibility of interest paid was not affected by the taxpayer not being an original subscriber to obligations of the United States (Art. 121; Sec. 214(a) (2)). The case of non-deductible interest arises most frequently in connection with individuals. Interest on loans with Liberty bonds of the first and fifth (334) issues (in the latter case not originally subscribed for) and municipal bonds as collateral, would not be deductible at all. Where there is a mixed group of collateral the apportionment of interest paid may be made on the basis of ratios existing between interest received from taxable (including the Fifth 434's Loan originally subscribed for) and interest received from non-taxable (including the Liberty Loan) bonds, or on the basis of the averaged principals of each class at par or at market prices. Where bank loans or other interest-bearing obligations are secured by tax-free collateral, the problem of apportioning the interest paid thereon becomes a problem to the corporate enterprise. Possible methods are as follows: (a) All interest paid is deductible despite the fact that collateral for loans consists of tax-free securities, the theory being that the loans are for the benefit of the business generally and not solely to "carry" such securities. This method should be followed unless the Department has ruled otherwise in a specific case. (b) Another method is to compute, from the collateral record, the portion of tax-free interest securities up for collateral (as in the case of individuals). (c) A third method is to apply to interest paid a fraction, the numerator of which is the yearly average of all municipals and the denominator the average of all securities, including municipals, held for trade, no matter whether or not used as collateral. (d) A fourth method is similar to and applicable to the same conditions as the third except that the denominator is the average of all current assets commonly included in working capital. Considering funds and their application in this type of enterprise, it is axiomatic that a bank loan represents an equal investment in a dollar's worth of municipal bonds, a dollar's worth of cash, or any other current asset. (e) The same principle as is used in computing the inadmissible 1 percentage for invested capital purposes 1 1 Inadmissible assets were assets (except obligations of the United States) may also be applied. This method resembles the third and fourth just described, the denominator being all assets and not merely the inadmissible or current assets. If the law regards a capital liability as invested ratably in current and capital assets a current liability must also be so invested. Penalty interest paid the Government in connection with additional taxes is deductible (O. D. 319 and O. 922) as well as interest overdue Federal estate taxes (I. T. 1317). Other deductible interest has included: 1. Interest paid under a guarantee agreement (S. 1298). 2. Discount sustained by a contractor converting municipal certificates of indebtedness (O. D. 999). 3. Interest paid charged to construction, no option being allowed the taxpayer even under the authority of a state utility commission (S. 935, overruling S. 23). 4. Interest on loans carried to cover losses sustained on the sale of Liberty bonds and to pay city taxes, although Liberty bonds were used as collateral (I. T. 1213). 5. Dividends on certain forms of debenture stock where the principal, interest, or both, rank superior to the claims of unsecured creditors (A. R. R. 237). 6. Interest on deferred dividends ordered paid by a court (O. D. 778). But interest on subscriptions to stock paid in advance or on instalments was held to be a distribution of profits (O. D. 991). TAXES Taxes are deductible, as a rule by all individuals and corporations and are not limited to business property. They include the following: (a) Local and state property taxes, including automobile license fees (Art. 131). the income from which was wholly or partially non-taxable and which, therefore, were excluded from invested capital to the extent the income was not subject to tax and to the extent that stockholders had an equity in them. In computing the equity no distinction was made between actual liabilities to outsiders and the "liability" of net worth. See Chapter XXI. |