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employed or the method employed does not clearly reflect the income in which case the computation is made on such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income.14 Thus, individuals and corporations may report their income upon the basis of accruals instead of actual receipts. This provision is more fully discussed in subsequent paragraphs of this chapter.15 If a taxpayer does not keep his accounts on such basis, the tax must be computed on the basis of actual receipts. An early ruling of the Treasury Department, under the 1913 Law, holding that a person receiving fees or emoluments for professional services must include all actual receipts for services rendered in the year for which the return was made, together with all unpaid accounts, charges for services or contingent income due for that year, was discussed in a case 16 in which the court said: "No such construction of the Treasury Department can enlarge the scope of the statute so as to impose the tax upon unpaid charges for professional services rendered, which for aught anyone can tell may never be paid. The statute alone determines what is income to be taxed. It taxes only income derived from many specified sources, and one does not derive income by rendering services and charging for them." Accrued but unpaid interest on investments has been held not to be income.17 Under the broader language of the 1909 Law it was held that income was taxable only to the extent that it was actually received during the year, and did not include items which had been earned, or become due, but had not been collected.18 was also held under that law that items of "non-ledger assets" shown in the annual report of a life insurance company, made in pursuance to a state statute as "uncollected and deferred premiums" and "interest due and accrued,'

14 Revenue Act of 1918, §§ 212 (b) and 232.

15 See page 320.

16 Edwards v. Keith, 231 Fed. 110.

17 Ins. Co. of North America v. McCoach, 218 Fed. 905. 18 Connecticut Mut. Life Ins. Co. v. Eaton, 218 Fed. 206.

It

but no part of which had been received, were not a part of the company's "income received during such year."

19

Constructive Receipt of Income. The rule stated in the foregoing paragraphs that the law taxes income "received" and not that which has "arisen or accrued" is subject to the qualification that income may be constructively as well as actually received. Actual receipt is a reduction to possession. Constructive receipt occurs where income is credited or made available to recipients and is to be reported as income; as for instance in the case of a credit to the account of recipients of savings-bank interest.20 A taxpayer is deemed to have received items of gross income which have been credited or made available to him without restriction. On the other hand, appreciation in the value of property is not even an accrual of income to the taxpayer prior to the realization of such appreciation through conversion of the property.21

BOOKKEEPING ENTRIES. Real facts and not bookkeeping entries constitute income. Books of account are no more

than evidential; they are neither indispensable nor conclusive.2 22 This does not mean that the return of net income should not be made in accordance with the taxpayer's books, for ordinarily the books reflect the real or actual facts. It means, for instance, that the Government is not precluded from going behind the taxpayer's books and assessing 'the tax on the actual facts. As a general rule, the method of accounting employed by a taxpayer determines his income. In some instances the law places a further determining importance on bookkeeping entries, as in the case of depreciation and in the case of worthless debts.2 23 The latter seems to be the only item of income

19 Connecticut General Life Ins. Co. v. Eaton, 218 Fed. 188. 20 Reg. 33 Rev., Art. 4.

21 Reg. 45, Art. 23.

22 Doyle v. Mitchell, 247 U. S. 179.

23 Under the 1916 Law this was true also of cases of losses which were required to be sustained and "charged off" in order to be deducted by corporations. (Revenue Act of 1916, § 12 (a).)

or deduction expressly required by the law to be evidenced by book entries in the case of individuals. No system of bookkeeping or accounting is prescribed for all taxpayers, but the business transacted by the taxpayer should be so recorded that he may make a return of his true income and that each and every item set forth in the return of income may be readily verified by an examination of the books of account.24 The books of a corporation are assumed to reflect facts as to its earnings, etc., hence they will be taken as the best guide in determining the net income, and, except as the same may be modified by provisions of the law wherein certain deductions are limited, the net income disclosed by the books and verified by the annual balance sheet, or the annual report to stockholders, should be the same as that returned for taxation.25 Where an individual or a corporation reports on the basis of its books, and not on the basis of actual receipts and disbursements, the books must be kept so as to clearly reflect income. This basis is more fully discussed in the latter part of this chapter.26

Book Value of Assets. Neither the Government nor the taxpayer is bound by valuations entered on the books of the taxpayer.27 Where property is carried at nominal value on the books of the taxpayer, and the Government seeks to assess a tax on the basis of that value, the taxpayer may prove, by other evidence, the true value of such property.28 A book value increase in the value of capital assets due to a re-appraisal of property is not income within

24 Reg. 45, Art. 24; Reg. 33, Art. 182; T. D. 2161.

25 Reg. 33, Art. 183.

26 See page 320.

27 Doyle v. Mitchell Brothers, 235 Fed. 686, affirmed 247 U. S. 179. 28 U. S. v. Guggenheim Exploration Co., 238 Fed. 231. In this case the value at which the property was acquired, the declaration of the board of directors as to such value, at the time of acquisition, and statements in the annual reports, were held to overcome in weight the alleged admission against interest in placing the valuation of the property on the books at a nominal amount.

the meaning of the law.29 A book entry reflecting only an enhanced value of assets during the year evidences an increase in the net worth of the corporation or individual for that year, an increase which, under adverse conditions, may disappear the next year. An increase in value thus evidenced is intangible, unstable.and is not such income as the law contemplates shall be returned for the purpose of the tax.30 Returnable and taxable income is that actually realized during the year, evidenced by the receipt of cash or its equivalent. Hence mere book entries of an appreciation in the value of capital assets will be disregarded.31

Inventory. Taxpayers engaged in manufacturing or mercantile business usually determine their net income by inventory, purchases during the year plus the stock on hand at the beginning of the year, being subtracted from sales during the year plus stock on hand at the close of the year, or vice versa, to ascertain the gain or loss. The Treasury Department's first recognition of this system required that in every case where the annual gain or loss was determined by inventory, the merchandise must be inventoried at cost price, as any loss in salable value would ultimately be reflected in the sales during the year when the goods were disposed of. This rule permitting inventories on the basis of cost only was later altered and new rules established for the purpose of income and excess profits returns, permitting inventories at cost or market value, whichever is lower.32 Except where inventories are allowed at cost or market, gain or loss must in all cases be determined on the basis of cost or of value as of March 1,

29 T. D. 2005, Baldwin Locomotive Works v. McCoach, 221 Fed. 59. 30 Letter from Treasury Department dated August 14, 1914; I. T. S. 1917, 260. See Reg. 45, Art. 23.

31 Reg. 45, Art. 23; Letter from Treasury Department dated August 14, 1914; I. T. S. 1917, ¶ 260.

32 T. D. 2609. The Attorney-General has advised on the basis of Doyle v. Mitchell Brothers, 247 U. S. 179, that the methods of taking inventories authorized by T. D. 2609 are permissible. (T. D. 2744; T. D. 2649.)

1913.33 In no cases should overhead charges be included in inventory.34 It is provided by the Revenue Act of 1918 that 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,35 and gain or loss is determined in the case of property acquired on or after March 1, 1913, on the basis of the cost thereof or inventory value, if the inventory is made in accordance with the above provision.

1.36

INVENTORIES OF MERCHANDISE. In order to reflect the net income correctly, inventories at the beginning and ending of each year are necessary in every case in which the production, purchase or sale of merchandise is an income-producing factor. The inventory should include raw materials and supplies on hand that have been acquired for sale, consumption or use in productive processes, together with all finished or partly finished goods. Title to the merchandise included in the inventory should be vested in the taxpayer and goods merely ordered for future delivery and for which no transfer of title has been effected should be excluded. The inventory should include merchandise sold but not shipped to the customer at the date of the inventory, together with any merchandise out upon consignment. It should also include merchandise purchased, although not actually received, to which title has passed to the purchaser. In this regard care should be exercised to take into the accounts all invoices or other charges in respect of merchandise properly included in

33 T. D. 2609.

34 See instructions on back of Form 1031 for 1916.

35 Revenue Act of 1918, § 203.

36 Revenue Act of 1918, § 202 (a) 2.

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