CHAPTER 28 DEDUCTION OF INTEREST The Revenue Act of 1918 provides that citizens and residents and domestic corporations may deduct all interest paid or accrued within the taxable year on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917), the interest upon which is wholly exempt from taxation as income to the taxpayer. Non-resident aliens and foreign. corporations may deduct that proportion of such interest which the amount of his or its gross income from sources within the United States bears to the amount of his or its gross income from all sources within and without the United States. But this deduction is allowed to a nonresident alien only if he files a true and accurate return of his total income from all sources, corporate or otherwise, in the manner prescribed 2 by the law. The special rules applicable to each of the four classes of taxpayers enumerated above and the extensive changes made by the Revenue Act of 1918 are discussed in the chapters relating to each. In all cases interest upon indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917), the interest upon which is wholly exempt from the income tax to the taxpayer, may not be deducted. 1 Revenue Act of 1918, §§ 214 (a) 2, 234 (a) 2. 2 Revenue Act of 1918, § 217. 3 See Chapters 4, 5, 12, and 14 on Citizens and Residents, Nonresident Aliens, Corporations, and Foreign Corporations respectively. Indebtedness Incurred or Continued to Purchase or Carry Tax Exempt Securities. Prior to its amendment by the Revenue Act of 1917, it was held under the 1916 Law that interest paid on indebtedness could be deducted regardless of whether or not the indebtedness was incurred for the purchase of bonds, the interest upon which was exempt from taxation. This ruling in effect permitted a double deduction, that is, the interest paid on the money so borrowed could be deducted and the income derived from the money so borrowed and invested could also be deducted. The 1917 Law did not permit the deduction of interest paid on "indebtedness incurred for the purchase of obligations or securities the interest upon which is exempt from taxation as income under this title."4 The Revenue Act of 1918 does not permit the deduction of interest paid or accrued on "indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917) the interest upon which is wholly exempt from taxation under this title as income to the taxpayer." 5 State and municipal bonds are obligations or securities falling within this class, as well as National bonds issued prior to September 1, 1917. Interest on indebtedness incurred for the purchase of Liberty bonds of the second issue (the interest on which is not entirely exempt from the surtax) was held deductible regardless of the limitation contained in the 1917 Law. By the parenthetical clause of the 1918 provision taking obligations of the United States issued after September 24, 1917, out of the exception to the deductibility of interest, the Revenue Act of 1918 makes it clear that interest on indebtedness incurred or continued to purchase or carry Liberty bonds of the second, third or fourth loan will be allowed as a deduction. The extension of the exception to the de 4 Revenue Act of 1916, §§ 5 (a), 12 (a), as amended by the Revenue Act of 1917. 5 Revenue Act of 1918, §§ 214 (a) 2, 234 (a) 2. 6 T. D. 2541. ductibility of interest to indebtedness "continued" as well as incurred, and incurred or continued to "carry" as well as to purchase tax-exempt securities should be noted. Interest Paid Within the Year. The 1909 Law provided for the deduction of "interest actually paid within the year" and it was contended by the Treasury Department that this provision required that the interest should be both accrued and paid within the same year. It was held, however, that interest actually paid within the year although previously accruing should be permitted as a deduction. The 1913 Law provided for the deduction of interest paid within the year by individuals, and "interest accrued and paid within the year" by corporations. In a ruling appearing under that law it was held that in the case of corporations the deduction should be limited to interest which had both accrued and been paid within the same year. The 1916 Law permitted the deduction of interest paid within the year."9 The Revenue Act of 1918 permits the deduction of interest "paid or accrued within the taxable year. 10 It does not seem essential under these provisions that interest should have accrued or become payable in the year in which it is paid in the case of taxpayers reporting on a basis of cash receipts and disbursements. Interest Paid or Accrued Within the Year. It will be noted that the Revenue Act of 1918 permits the deduction of interest "paid or accrued" within the taxable year.11 The term "paid or accrued" is to be construed according to the method of accounting upon the basis of which the 7 Anderson v. 42 Broadway Co., 213 Fed. 777. The Supreme Court in reversing the lower court (239 U. S. 69) did not pass on the question of deducting interest accrued in one year and paid in another. 8 T. D. 1960. 9 Revenue Act of 1916, §§ 5 (a), 12 (a), as amended by the Revenue Act of 1917. 10 Revenue Act of 1918, §§ 214 (a) 2, 234 (a) 2. 11 Revenue Act of 1918, §§ 214 (a) 2, 234 (a) 2. net income of the taxpayer is computed.12 Under the 1916 Law corporations keeping books of account on an accrual basis were permitted to deduct interest for the year whether paid or not, when such interest was shown as a charge against accrued income upon the books of account.13 Interest Paid by Corporations. The limitations imposed by the 1916 Law upon the amount of interest which might be deducted by domestic and foreign corporations are referred to elsewhere in this book.14 12 Revenue Act of 1918, § 200. 13 T. D. 2625. 14 See Chapters 12 and 14 on Corporations and Foreign Corporations respectively. CHAPTER 29 DEDUCTION OF TAXES In the case of citizens and residents and domestic corporations the provisions of the Revenue Act of 1918 for the deduction of taxes are the same. Such taxpayers may deduct taxes paid or accrued within the taxable year imposed (a) by the authority of the United States, except income, war-profits, and excess-profits taxes; or (b) by the authority of any of its possessions, except the amount of income, war-profits and excess-profits taxes allowed as a credit against the tax of the taxpayer; or (c) by the authority of any State or Territory, not including those assessed against local benefits of a kind tending to increase the value of the property assessed; or (d) by the authority of any foreign country except the amount of income, warprofits and excess-profits taxes allowed as a credit against the tax of the taxpayer. Non-resident aliens and foreign corporations may deduct the taxes included in items (a), (b), and (e) above; in lieu of the taxes included in item. (d) above they are allowed to deduct taxes imposed by the authority of any foreign country (except income, warprofits and excess-profits taxes, and taxes assessed against local benefits of a kind tending to increase the value of the property assessed).1 The deduction of taxes by non-resi 1 Revenue Act of 1918, §§ 214 (a) 3, 234 (a) 3. In the case of non-resident aliens and foreign corporations the taxes which might be deducted were limited to those assessed by the United States or its territories or possessions or under the authority of any state, county, school district or municipality or other taxing subdivision of any state, paid within the United States, within the year, except such taxes as were not deductible by any class of taxpayers. (Revenue F. T.-29 449 |