during the year, even though at the rate of interest paid (6%) such amount was less than 6% of the maximum principal. (Letter from Treasury Department dated April 29, 1918; I. T. S., 1918, ¶ 3344.)

Paid Up Capital Stock Outstanding at the Close of the Year. This phrase meant the par value of shares issued as reported in Item 1 of the return form and did not include the surplus carried by the corporation. The full amount of stock represented by the par value of the shares issued was regarded as the paid up capital stock, except when such stock was assessable on account of deferred payments, or payable in installments, in which case the amount actually paid on such shares constituted the actual paid up capital stock. (T. D. 2090; Reg. 33, Art. 95.) Where the capital stock of the corporation was issued without par or nominal value, the law provided that the amount of capital stock as represented by such shares would be the amount of cash or its equivalent paid or transferred to the corporation as a consideration for such shares. If such shares were issued as a bonus in connection with shares of preferred stock, the par value of the preferred stock would be the limit which might be claimed as paid up capital stock. If both common and preferred were issued for cash or other equivalent consideration, the amount would be the par value of the preferred stock plus the amount actually paid in on the shares issued without par value. (Letter from Treasury Department dated January 13, 1916; I. T. S. 1918, ¶ 1767.) Neither in the case of stock issued with a par value nor in the case of stock issued without par value could the amount of paid up capital stock be increased except as new capital was paid in and for which additional shares were issued. (Letter from Treasury Department dated January 13, 1916; I. T. S. 1918, 1767.)

Interest Paid by Banks on Deposits. In the case of a bank, banking association, loan or trust company, the interest paid on deposits or on moneys received for investment and secured by interest-bearing certificates of indebtedness issued by such bank, banking association, loan or trust company was permitted to be deducted in full. Where a corporation, chartered as a bank, was engaged in the business of selling debenture bonds and guaranteed real estate securities, by a method by which it both paid and received interest, it was held under the 1909 Law that the interest paid out could not be deducted in full as interest paid on deposits, the transaction in no way being a banking transaction. (Middlesex Banking Co. v. Eaton, 233 Fed. 87.) Such interest could probably be deducted as interest paid on indebtedness secured by collateral.

Car Trust Certificates. Railroad companies were permitted to include these trust certificates in the amount of their bonded or other indebtedness reported. (Reg. 33 Rev., Art. 188.)

Interest on Indebtedness Secured by Collateral. The deduction of such interest was permitted without limit provided (a) the indebtedness was wholly secured by property collateral, tangible or intangible, (b) the collateral was the subject of sale or hypothecation in the ordinary business of the corporation as a dealer in such property or in loaning the funds thereby produced and (c) the indebtedness did not exceed the actual value of such property collateral. Such interest was deductible not as interest paid, but as an expense of doing business. The deduction was required to be stated separately in the return of annual net income and was required to be segregated from indebtedness not so secured. Failure to segregate the two forms of indebtedness resulted in a suspension or disallowance of the amount claimed. (T. D. 1993.)

Collateral the Subject of Sale. This phrase as used in the law referred to tangible or intangible property bound for the performance of certain covenants or payment of certain obligations. Real estate owned and mortgaged by corporations organized for and engaged in the business of buying, selling and dealing in real estate, warehouse receipts representing property the subject of sale in the ordinary business of the corporations owning same, and which warehouse receipts were pledged as collateral for such corporations' own debt, were examples where the interest would be deductible without limit. (T. D. 2090.) If a corporation whose ordinary business was the purchase and sale of real estate had an office building under mortgage, which office building was not subject to sale in the ordinary business of the corporation, the interest paid on such mortgage might not be deducted without limit. (T. D. 2137.)

As a Dealer Only. The only corporations allowed under this proviso to deduct interest in full were those organized and operated for the purpose of buying, selling and dealing in the particular kind of property upon which the mortgage was given, and the particular property pledged for the debt upon which the interest was paid was required to be the subject of sale in the ordinary business of the corporation. (T. D. 1993.)

Ordinary Business of the Corporation. Where a corporation dealt in the property serving as collateral for the indebtedness as a matter of its ordinary business, deduction might be made in full, but where the property was held by it for the purpose of, or as an instrument in carrying on, its ordinary business such as the rights of way and other property of public utility companies, permanent office buildings and property of like character held or occupied for the particular use or purpose or the furtherance of the objects of the corporation, the property was held not to be the subject of sale in its ordinary business, but to be occupied or used as an instrument of carrying on the ordinary business for the transaction of which the corporation was organized. The fact that such property might be subject to sale under extraordinary or peculiar conditions did not qualify it as collateral. (T. D. 1993.)

CHAPTER 13

SPECIAL PROVISIONS APPLYING TO INSURANCE COMPANIES

In the case of insurance companies, both domestic and foreign, certain special provisions govern the calculation of gross income and the making of deductions.1 In general domestic insurance companies are subject to the same provisions as other domestic corporations and foreign insurance companies are subject to the same provisions as other foreign corporations. The foregoing chapter should be consulted as to the general provisions relating to corporations and the following chapter should be consulted as to the special provisions applicable to foreign corporations. Under the 1916 Law two special forms for making the return of income were provided for insurance companies, one to be used by mutual insurance companies other than mutual life and mutual marine, and the other to be used by all other insurance companies including mutual life and mutual marine.2

Gross Income. The gross income of insurance companies is determined in the same manner as in the case of other corporations except that (a) in the case of life insurance companies it does not include such portion of any annual premium received from any individual policy holder as is paid back or credited to or treated as an abatement of premium of such policy holder within the taxable year and (b) in the case of mutual marine insurance companies it does include the gross premiums collected and received by such companies less amounts paid for rein1 Revenue Act of 1918, §§ 233 (a) 1 and 2, 234 (a) 10, 11, 12 and 13.

2 Forms No. 1030 and 1030A.

surance.3 Gross income includes net premiums, investment income, income from the sale of capital assets, and all gains, profits and income reported to the State insurance departments, except income specifically exempt from tax. Amounts of premium received and paid out under reinsurance treaties should be eliminated from both income and disbursements. Deposit premiums on perpetual risks received and returns should be treated in the same manner, as no reserve will be considered covering liability for such deposits, but the earnings on such deposits will be included in the investment income. A net decrease in reserve funds within the taxable year must be included in the gross income.3a

Expenses. The same allowance for expenses is permitted as in the case of other corporations. Insurance companies will be permitted to add to expenses, in lieu of depreciation of furniture and fixtures, the actual cost of repairs, replacements and renewals of such furniture, as is reported to the state insurance department, provided that in the case of an original investment, the cost thereof shall be charged to capital account.

Deduction of Net Addition to Reserve Funds. Insurance companies may deduct the net addition required by law to be made within the taxable year to reserve funds. This is considered to mean the net addition required by the specific statutes of the states within which the taxpayer transacts business.5 The net addition may be based upon the highest authorized reserve required by the statutes of any state in which the company does business, but having adopted the requirements of one state the company cannot base its reserve upon the requirements of another state for subsequent years. Only reserves commonly recognized as reserve funds in insurance account

3 Revenue Act of 1918, § 233 (a) 1 and 2. 3a Reg. 45, Art. 546; Reg. 33 Rev., Art. 239. 4 Reg. 33 Rev., Art. 240.

5 Reg. 45, Art. 570.

6 T. D. 1727; Reg. 33 Rev., Art. 240.

ing are to be taken into consideration in computing the net addition to reserve funds required by law. In the case of a fire insurance company the only reserve fund commonly recognized is the "unearned-premium" fund. The net addition to the fund maintained to pay incurred losses is not a legal deduction from gross income. In the case of casualty companies reserve funds consist of amounts maintained to meet the "unearned-premium" liability and the "unpaid-loss" liability. In the case of life insurance companies the net addition to the "reinsurance reserve" and the "reserve for supplementary contracts not involving life contingencies," and the net addition to any other reserve funds necessarily maintained for the purpose of liquidating policies at maturity, are legally deductible. An increase in the amount maintained by a life insurance company to pay dividends on deferred dividend policies may not be deducted from gross income. An assessment insurance company is entitled to deduct from gross income the increase in the amount which it is required by law to keep on deposit with State insurance departments as a protection to policyholders. Mutual hail and mutual hail and cyclone insurance companies are entitled to deduct from gross income the net addition which they are required to make under the laws of the states in which they operate to the "guaranty surplus" fund or similar fund. The income tax law specifically limits the deductions to sums required by law, not such reservations as business prudence may suggest, and the express provisions of the law fix the determining basis.7

RESERVES REQUIRED BY LAW. As a general rule, only those reserves which are "required by law" may be deducted. Under the laws of Pennsylvania reserves against unpaid losses are required by law of casualty companies, but not of fire and marine insurance companies. Hence,

6a Reg. 45, Art. 570.

7 Maryland Casualty Co. v. U. S., 52 Ct. Cls. 201; T. D. 2451. This case is now No. 395 on the docket of the United States Supreme Court.