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CHAPTER 46

THE CAPITAL STOCK TAX

This tax is popularly known as the capital stock tas, but the statute describes it as “a special excise tax with respect to carrying on or doing business."i The tax is imposed upon, “Every corporation, joint-stock company or association, now or hereafter organized in the United States for profit and having a capital stock represented by shares, and every insurance company, now or hereafter organized under the laws of the United States, or any state or territory of the United States and upon, Every corporation, joint-stock company or association, or insurance company, now or hereafter organized for profit under the laws of any foreign country and engaged in business in the United States." The tax is imposed for the privilege of carrying on or doing business for the taxable year and is payable in advance by every taxable corporation engaged in business during any part of the preceding year.

Definitions. The word “corporation" as used in this chapter means, unless otherwise stated, a corporation, joint-stock company, association, or insurance company. The phrase “taxable year” is the fiscal year of the Government beginning July one of each calendar year and ending on the last day of June of the year following. The phrases "preceding year" and "preceding taxable year" as used in the Statute mean the twelve-month period ending June 30, preceding the taxable year.

1 Act of September 8, 1916, 407.

Domestic Corporations Subject to the Tax. The tax applies to corporations, joint-stock companies or associations organized in the United States, provided they are (a) organized for profit, (b) have capital stock represented by shares, (c) were engaged in business during the preceding taxable year, and (d) are not exempt organizations under the provisions of Section 11 of the 1916 Income Tax Law. It should be noted that the law applies not only to corporations but to all associations organized in the United States” and in this respect seems to be broader in its scope than the 1909 Law, which was construed to apply only to corporations, jointstock companies or associations “organized under the laws of the United States or of any state or territory of the United States or under the Acts of Congress applicable to Alaska or the District of Columbia. apparently the intent of Congress to make this law apply to associations which were held not to be taxable under the 1909 Law, because not organized under some statute. 4

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2 For a discussion of corporations exempt from tax under the 1916 Income Tax Law, see Chapter 15.

3 Act of August 5, 1909, § 38.

4 It was the intention of Congress to embrace within the 1909 Law only such corporations and joint-stock associations as are organized under some statute or derived from that source some quality or benefit not existing at the common law. (Eliot v. Free. man, 220 V. S. 178.) This was a case involving the so-called “Massachusetts Real Estate Trusts” and the Treasury Department has indicated that it will not hold such trusts subject to the capital stock tax. It seems, nevertheless, that Congress had a definite intention to include such organizations by using the phrase

The language of the two laws not being identical, decisions under the 1909 Law are not controlling with respect to this law. It seems, rather, that any corporation or association subject to the 1916 Income Tax Law would be subject to the capital stock tax law (providing the other conditions co-exist) since the language of Section 10(a) of the 1916 Law has phraseology very similar to the language of this law.5

Insurance Companies. It seems that an insurance company in order to be subject to this tax must be organized under the laws of the United States, or any state or territory of the United States. An insurance company not organized under some statute would not be subject to the tax although it may have capital stock represented by shares. If organized under a statute the other elements must co-exist, that is, it must have been organized for profit, must be engaged in business and must not be one of the classes of corporations specifically enumerated as exempt in the 1916 Income Tax Law. Although the law imposes the tax on insurance companies without reference to whether or not they have capital stock represented by shares it has been held by the Treasury Department, inasmuch as the basis of tax is the fair value of the stock of the corporation, that mutual insurance companies and other associations not having capital stock represented by shares will be held

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“organized in the United States" instead of the phrase “organized under the laws of the United States or of any state or territory of the United States,” which latter phrase was used in the 1909 Law and was the precise language on which this case was decided.

5 For rulings under the 1916 Law on joint-stock companies and associations see Chapter 12.

exempt from the tax, in the absence of a basis for the computation thereof.

Holding Companies. A holding company, as such, is not exempt from this tax. The Treasury Department has held that a holding company organized in the United States for the purpose of acquiring and holding capital stock of subsidiary companies, and actually engaged in holding such stock, voting thereon, receiving dividends thereon, and distributing money among its own shareholders, is engaged in business and is subject to this tax.? Both holding companies and their subsidiary corporations are required to file returns and pay the tax, no deduction being allowed to the holding corporation for the tax assessed on its subsidiary.8

Subsidiary Companies. A subsidiary company is taxed on the fair value of its capital stock, although the parent company is also taxed on the value of its capital stock, represented by the stock of such subsidiary.

It has been held that in order to determine the fair value of capital stock of subsidiary companies, the fair value of the capital stock of the parent company, determined from the prices listed on an exchange or from actual sales, may be apportioned among the subsidiaries according to the amount of net profits earned by each during the year, making due allowance for the amount of net profits earned by the parent corporation from actual operations and investments or holdings in stock of companies other than its subsidiaries. As an illustration, assume that the fair value of the capital stock of a parent company is $5,000,000 and that it derived one-fifth of its income during the preceding year from operations and investments in securities, other than stock of its two subsidiaries. In such case, one-fifth of the fair value of its capital stock will be ascribed to capital used in its operations and outside investments, four-fifths, or $4,000,000, being ascribed to the capital stock of the subsidiaries. Assume further, that one of the subsidiaries had net income of $600,000 and the other had net income of $200,000. The aggregate net income of the subsidiaries would be $800,000, three-fourths of which would be earned by the one and one-fourth by the other. Consequently, the value of the capital stock of the one would be three-fourths of $4,000,000, and the value of the capital stock of the other would be one-fourth, or $3,000,000 and $1,000,000 respectively. Where the value of the stock of a subsidiary company is determined on this basis, the Treasury Department requires a statement showing the fair value of capital stock of the parent company, its earnings for the preceding year, the amount of such earnings derived from operations and outside investments, and the net earnings of each subsidiary.10

6T. D. 2364.

T. D. 2429. 8T. D. 2503. 9 T. D. 2493.

Corporations Not Engaged in Business. Since this is a tax with respect to the carrying on or doing business by a corporation, it follows that only such corporations as are engaged in business are subject to the tax. The meaning of the term "engaged in business" was defined by a number of decisions under the 1909 Law, with particular reference to cases where corporations had ceased to do business. Thus, it was held that where a corpora

10 T. D. 2493 as amended by T. D. 2509.

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