ments of the business had ceased.25 Thus if a corporation which invested a portion of its undistributed net income of the previous year in obligations of the United States issued after September 1, 1917, sold such obligations after the expiration of the six months, it was held that the proceeds of the sale became subject to the 15% tax unless such earnings were immediately distributed or actually invested or employed in the business, or retained for employment in the reasonable requirements of the business.26 This last ruling, however, seems to extend the tax beyond the express purport of the law, which seemed to impose this 15% tax only with respect to "any portion of such amount so retained at any time for employment in the business." There was nothing in the law which required the corporation to retain such bonds so long as they were owned on a date six months after the close of the taxable year.

Returns. Every corporation required by the 1916 Law as amended to make a return of its annual net income, and which had a taxable net income for the preceding taxable year, was required to make a return of the amount of such net income received during such taxable year remaining undistributed six months after the end of such taxable year. The return was sworn to by the president, vicepresident or other principal officer, and by the treasurer or assistant treasurer of the corporation, and was made to the Collector of Internal Revenue of the district in which its return of annual net income was required to be filed.

25 T. D. 2736. The tax of 15% is in the nature of a penalty tax. It should be noted that this provision practically made the Secretary of the Treasury judge as to when the earnings were employed in the business, or what the reasonable requirements of the business might be. The provision was intended as a means of deterring officers of corporations from making too liberal allowances for the reasonable requirements of the business. In effect, it imposed a penalty of 50% of the amount of the tax for understatement of the taxable undistributed earnings.

26 Letter from Treasury Department dated May 23, 1918; I. T. S. 1918, 3438.

Such return was required to be made within sixty days after the expiration of six months after the end of such taxable year, except that any corporation which would otherwise be required to make a return on or before a date earlier than August 1, 1918, might make such return on or before August 1, 1918.27

Penalties. If the tax assessed on undistributed net income was not paid within ten days after the date of notice and demand therefor it was the duty of the collector to make collection with a penalty of 5%, additional upon the amount thereof and interest at the rate of one per cent a month. In case of any failure to file a return within the time prescribed by law 50% of the amount of the tax was added thereto, except that when a return was voluntarily and without notice from the collector filed after such time, and it was shown that the failure to file it was due to reasonable cause and not to wilful neglect, no such addition was made to the tax. In case a false or fraudulent return was wilfully made, 100% of the amount of the tax was added thereto. Corporations, officers thereof, and other individuals required to make, render; sign or verify returns of corporations were subject to the specific penalties provided by law for refusal or neglect to make such returns and for making false or fraudulent returns.28

27 T. D. 2736. Form No. 1112 was used in making the return. 28 T. D. 2736.

CHAPTER 45

WAR-PROFITS AND EXCESS-PROFITS TAX

The Act of March 3, 1917, was the first excess-profits tax law enacted in this country. That statute imposed a tax of 8% on all net income in excess of the sum of $5,000 plus 8% of the actual capital invested. It applied only to corporations and partnerships. A small amount of tax was collected under that statute from corporations whose fiscal years ended in the succeeding months but any amounts so collected were credited or refunded to the taxpayers. On October 3, 1917, the second excess-profits tax law was enacted, which imposed a tax on the net income of individuals, partnerships and corporations, derived from any business or trade. This statute (referred to in this Chapter as the 1917 Law) was retroactive to January 1. 1917, and covered the period during which the Act of March 3, 1917, had been in effect. The rates of the 1917 Law as applied to corporations having invested capital were 20% of that part of the net income which exceeded the excess-profits deduction and did not exceed 15% of the invested capital; 25% on that part of the net income which exceeded 15% of the invested capital and did not exceed 20% of the invested capital; 35% of the net income which exceeded 20% of the invested capital and did not exceed 25% of the invested capital; 45% on that part of the net in139 Stats. at Large 1000.

2 The statute defined the term "actual capital invested" to mean (1) actual cash paid in; (2) the actual cash value at the time of payment of assets other than cash paid in, and (3) paid in or earned surplus and undivided profits used or employed in the business; but to exclude money or other property borrowed.

come which exceeded 25% of the invested capital and did not exceed 33% of the invested capital; and 60% on that part of the net income which exceeded 33% of the invested capital. In the case of a trade or business which had no invested capital or not more than a nominal capital, the excess-profits tax was 8% on the entire net income in excess of $3,000 in the case of a domestic corporation and $6,000 in the case of a domestic partnership, or a citizen or resident of the United States. In the case of a foreign corporation or partnership or a non-resident alien this rate was imposed upon the entire net income without deduction. The Act of February 24, 1919, (referred to in this Chapter as the Revenue Act of 1918, the 1918 Law, or the present law) imposes a tax on income received during the year 1918 in lieu of the tax imposed by the 1917 Law. In view of the increased individual normal and surtax rates upon the income of individuals and partnerships, which in most cases will make the income taxes paid by such individuals as high as the income and excess or war-profits taxes paid by corporations engaged in similar business, and in view of the difficulty in administering an excess-profits tax applicable to individuals, it was decided by Congress that the war-profits and excess-profits taxes should apply to corporations only.3 It was also recognized that there exists a class of corporations which require very little or no invested capital and whose income is derived mainly from the personal services of the stockholders. Examples of such corporations are corporations composed of engineers or accountants, who might as readily have formed partnerships to carry on the business. Such corporations are called "personal-service corporations" and are treated as though they were partnerships. No excess-profits tax is imposed upon their net income but the stockholders of the personal-service corporation are taxable upon the entire net income of the year whether or not such income is distributed in the form of dividends.

3 Report of the Committee on Ways and Means on the Revenue Bill of 1918, September 3, 1918.

The tax imposed by the present law combines two general principles of taxation: (a) that of a war-profits tax, which is usually considered to be a tax on the excess of profits made during the years of the war period over the normal profits of the years prior to the war and (b) an excessprofits tax, which is usually considered to be a tax upon the profits in excess of a specified percentage representing an approximate normal return on the invested capital. The law, however, does not adhere to a clear distinction Letween war-profits and excess-profits since the war-profits tax combines a feature of the excess-profits tax in that a minimum deduction of 10% of the invested capital is allowed regardless of the earnings of the corporation during the prewar period. Under the excess-profits method of computing the tax the rate is graduated, 30% being applied to that part of the net income which exceeds the excessprofits deduction and does not exceed 20% of the invested capital and 65% being applied to that part of the income which exceeds 20% of the invested capital. The war-profits tax rate is a single rate of 80% in excess of the war-profits credit. It has been estimated that under the 1917 Law the average amount of excess-profits tax was about 30% of the net income of corporations for the year 1917. It is conjectured that the war-profits and excess-profits tax will absorb on an average about 45% of the 1918 income. In addition the income tax will absorb 12% of the remainder so that it is probably safe to predict that about one-half of the net income of corporations for the year 1918 will be paid to the Federal Government by way of war-profits, excess-profits and income taxes.

Individuals. Individuals are not subject to the warprofits and excess-profits tax. Since individuals were not allowed to file returns for their fiscal years under the 1917 Law no individual has paid a tax on 1918 income under the 1917 Law and, therefore, the 1918 Law contains no provision with respect to individuals such as the provision with respect to partnerships for redetermining the tax due on 1917 income.