The question was presented to Congress when the revenue bill of 1926 was before it, and though neither section 212 (d) nor section 1208 dealt specifically with the question whether the regulations of 1919 or those of 1921 were to be applied, the report of the conference committee to the Senate contains the explicit statement that—

In the application of this provision it is intended that the installment provisions of Regulations 45, promulgated on December 25, 1919, will be substantially followed in settling all cases under prior acts and under this bill.

The House conference report is to the same effect. We see no reason for a change in this position. It may be said that with taxes reduced and more nearly uniform the objection to giving relief from double taxation is lessened. Equally, however, the need for any option or change of method is lessened. There is little reason why corporations should to-day be contemplating a change to the installment basis unless their installment business is new or for the first time assuming real importance, and in such cases the double taxation will not be serious and there will still probably be a tax advantage in the change in spite of it. Corporations which have been in the installment business for a number of years should have made their election before now and certainly should not be offered a substantial inducement to adopt a method they have hitherto declined to adopt. We see no reason, therefore, to change the existing rules covering the period of transition either for the past or for the future.

There are a number of cases in the bureau which had been closed on the basis of the regulations as revised in 1920 by the elimination of the double-taxation feature, and the bureau appears to feel that it is its duty under the act of 1926 to reopen these cases and redetermine the tax. It is very clear that such reopening is inexpedient and unnecessary and it is suggested that in the next revenue act proper provision should be made that where returns were filed and accepted under regulations in force and the cases have been closed the cases should remain closed and no attempt should be made to collect additional sums from the taxpayers in respect of the years covered by such returns. The war taxes were bound to operate with some inequitable results, and it is impossible now to remedy all such inequities. The need now is to dispose finally of cases for those years, and the bureau should not, in general, be required, nor should it undertake except in case of fraud, to reopen cases once disposed of in accordance with existing regulations.

Section 212(d) of the Revenue Act of 1926 sets up a distinction between dealers in real property and dealers in personal property, in so far as granting them the installment basis is concerned, to the effect that while the installment basis is allowed dealers in personal property without consideration of the extent of initial payment, it is allowed dealers in real property only if the initial payment does not exceed 25 per cent.

Considerable criticism has been leveled against this restriction as affecting real property dealers on the grounds of (1) inequality, in that the basis should not be different for dealers in real property and dealers in personal property, and (2) hardship, in that the denial of the installment basis, because of the 25 per cent limitation, produces a situation where cash is not available with which to pay taxes on the completed sales.

A distinction between the ordinary dealer in real estate and the ordinary dealer in personal property is clearly warranted, and, in fact, necessary to the effective administration of the income tax law. The vendor of real estate who takes 25 per cent of the sale price in cash is usually fairly assured of the ultimate collection of the balance and apart from tax considerations can afford to allow the balance to be secured by mortgage and paid over a long period of years. If at any time he should desire to turn the deferred obligation into cash, he would be in a position to do so at relatively small sacrifice. If he were given the added incentive that by so postponing the collection he could postpone payment of tax on his profit, the result would inevitably be that collection and payment of tax would be deferred in a large percentage of cases. In the case of the ordinary installment-sale dealer in personal property, however, the risks are usually such that the taxpayer can not afford to lengthen the period over which collections would be spread in order to postpone the tax.

There are, however, certain classes of real-estate transactions which are subject to as great uncertainties as installment sales of personal property, and, indeed, to even greater uncertainy. Examination of cases relating to speculative land projects, such as some undertaken in recent years in Florida or in the Muscle Shoals region of Alabama, shows that the gross profit, if the proceeds of sale are collected in full, frequently runs from 50 per cent to 200 per cent, or even 300 per cent. The sales are consummated on what is ordinarily known as open-sales contracts, requiring some payment down and the balance over four to six years in periodic installments. In the case of the Muscle Shoals dealers, no mortgages were taken, the contract of sale merely providing that payments were to be made at stipulated times, and that in the event of default the property could be taken back by the vendor.

In such cases it is clear that the obligations received from purchasers are not equivalent to cash in the amount of their face value any more than are such obligations received from the purchaser of personal property sold on the installment plan. The remedy, however, does not appear to be the elimination of the 25 per cent limitation for all real-estate dealers, nor even for dealers in this highly speculative class. It is apparent, for instance, that the application of the installment method of accounting to many Florida real-estate ventures would result in the taxation of profits which were never in fact realized.

The conclusion has been reached that the most effective and just form of relief in such cases would be the adoption of a rule under which the proceeds of sale may be applied first against the cost until the cost has been recouped, all subsequent receipts being treated as income. Such a method of accounting is recognized in article 46 of the existing regulations, but in that article it is made applicable only where obligations received have no fair market value, and in practice the regulation has been given a very limited application. The bureau has, in general, insisted that obligations received (unless they are worthless) have some value and must therefore have a fair market value.

In earlier statutes Congress recognized that property may have a value and yet not have a fair market value that is determinable with a sufficient degree of certainty to warrant making it the basis for

the computation of a tax, and laid down rules for taxation to meet such cases. In the act of 1918 it provided that property received in exchange should be treated as the equivalent of cash to the amount of its fair market value, if any; in the 1921 act provision was made. that on an exchange no gain or loss should be recognized unless the property received in exchange had a "readily realizable market value."

It seems to us that these provisions properly applied would have afforded any necessary relief in the more speculative class of realestate transactions, and we recommend the reinsertion of provisions of somewhat the same general import in the new revenue law. In order to overcome the apparent reluctance of the Treasury to apply such methods, we suggest that the language employed should be amplified; specifically, it is proposed that the commissioner should not treat obligations received from the sale of property as the equivalent of cash unless such obligations have a fair market value ascertainable with substantial accuracy by the application of standards customarily accepted in business practice. Such a rule would avoid the absurdity not infrequently encountered under the existing law of the commissioner contending that property has a fair market value but claiming at different times widely differing figures as the amount of that fair market value.

CONSOLIDATED RETURNS

(Section 240)

The Revenue Act of 1926 in section 240 continues the policy inaugurated during the war period which permitted affiliated corporations to file returns of their consolidated net income. The interpretation of this section, as well as its administration, is still the subject of much controversy and difficulty. A study of the operation and effect of the consolidated-returns provision has therefore been made and the results are submitted herewith.

SYNOPSIS

1. The primary purpose of the Congress, in enacting this provision in the Revenue Act of 1918, was to provide a "sound, equitable, and convenient" method of taxation for both the taxpayers and the Government. The secondary purpose was "to prevent evasion of taxes."

2. The consolidated-returns provision appears to have been justified under the excess-profits tax partly for the reason that invested capital computations were required and net losses were not permitted to be carried forward to subsequent years.

3. Under present conditions this section does not entirely prevent tax avoidance and gives to the affiliated corporations different treatment in some respects than that given to separate corporations.

4. A consolidated-returns provision which permits benefits other than the mere right to offset the loss of one corporation against the gain of another no longer appears to possess advantages sufficient to offset the many difficult problems of law and administration to which it gives rise.

RECOMMENDATIONS

1. The statute should be so framed as to treat affiliated corporations the same as separate corporations, except as to the right to offset the operating loss of one corporation against the gain of the other in the same taxable year.

2. Class B affiliations (the class in which 95 per cent of the stock of two or more corporations is owned by the same interests) should be abolished.

DISCUSSION OF RECOMMENDATIONS

Purpose of the consolidated provision. The purpose for which section 240 was inserted in the income tax laws is disclosed by the following extract from the report of the Finance Committee on the Revenue Bill of 1918:

Provision has been made in section 240 for a consolidated return in the case of affiliated corporations for purposes both of income and profits taxes. A year's trial of the consolidated return under the existing law demonstrated the advisability of conferring upon the commissioner explicit authority to require such returns.

So far as its immediate effect is concerned, consolidation increases the tax in some cases and reduces it in other cases, but its general and permanent effect is to prevent evasion, which can not be successfully blocked in any other way. Among affiliated corporations it frequently happens that the accepted intercompany accounting assigns too much income or invested capital to company A and not enough to company B. This may make the total tax for the corporation too much or too little. If the former, the company hastens to change its accounting method; if the latter, there is every inducement to retain the old accounting procedure, which benefits the affiliated interests, even though such procedure was not originally adopted for the purpose of evading taxation. As a general rule, therefore, improper arrangements which increase the tax will be discontinued while those which reduce the tax will be retained.

In

Moreover, a law which contains no requirement for consolidation puts an almost irresistible premium on a segregation or a separate incorporation of activities which would normally be carried as branches of one concern. creasing evidence has come to light demonstrating that the possibilities of evading taxation in these and allied ways are familiar to the taxpayers of the country. While the committee is convinced that the consolidated return tends to conserve not to reduce the revenue, the committee recommends its adoption, not primarily because it operates to prevent evasion of taxes or because of its effect upon the revenue but because the principle of taxing as a business unit what in reality is a business unit is sound and equitable and convenient both to the taxpayer and to the Government. (Senate Rept. No. 617, 65th Cong., 3d sess., pp. 819.)

This report of the Finance Committee indicates that Congress enacted section 240 for a dual purpose-to prevent tax evasion and to provide a sound, equitable, and convenient method of taxation. It is apparent that its primary purpose was to provide for a sound, equitable, and convenient method of taxation. The bureau has had an experience of nine years in the application of this provision. The results obtained in the past and the difficulties encountered should reveal the necessity for its retention or disclose a basis for its revision. The revision made in this section in the Revenue Acts of 1924 and 1926 eliminated only a few of the difficulties in the prior statutes and added provisions that are perhaps equally objectionable and difficult of application.

Difficulties of interpretation and administration.-A complete discussion of all the difficulties encountered in the interpretation and

administration of the various consolidated returns provisions would require a voluminous and technical report. The following questions indicate the principal difficulties which have arisen. Some of these questions have been partly answered by the Board of Tax Appeals while others are still in controversy:

1. What is meant by "substantially all the stock"?

2. When does "control" exist?

3. What are "closely affiliated interests"?

4. What are the same interests"?

5. What constitutes an election to file a consolidated return and when must it be made in order to be effective?

6. What are "related trades or businesses "?

7. When are such "related trades or businesses" "owned or controlled by the same interests"?

8. How shall accounts be "consolidated "-i. e., to what extent, if at all, shall the principles of a consolidated return apply?

9. What constitutes an agreement as to allocation of tax and when must one be made to be effective?

10. Where tax has been allocated and paid according to agreement, and it is later discovered that one or more of the group which paid none of the tax was actually nonaffiliated, but had income, how shall credit or refund be made?

11. Where tax was allocated and paid, as in 10, and prior to running of statute of limitations, one of the affiliated corporations passes to other interests and claims a refund, who is entitled to refund?

12. Where tax is allocated by agreement to an insolvent member of the affiliated group, how shall the tax be collected?

13. Where the tax has been assessed erroneously against one member of the group, may part of such assessment be credited to a member of the group which paid no part of the tax?

In addition to the above specific difficulties other general difficulties arise from the method of consolidation employed. The most important of these are as follows:

1. Application of net-loss provisions, especially when there has been a change in affiliation status during the years affected by those provisions.

2. Effect on consolidated net income of the liquidation of one or more members of the affiliated group.

3. Treatment for income-tax purposes of profits or losses resulting from sales of stock of members of the group to nonaffiliated interests. 4. Basis to be used for computing depletion, depreciation, and gain or loss on sale or other disposition of assets where cost or other basis to subsidiary is different from cost of latter's stock to the parent. Almost impossible situations have occurred in this connection, especially where minority interests are involved.

5. Complicated accounting problems in eliminating intercompany transactions.

It results from the interpretation now placed on section 240 in regard to the above questions and the method of consolidation employed, that affiliated corporations often receive substantially different treatment from separate corporations. One hypothetical case based on the principles of recent Board of Tax Appeals decisions will make this clear.