TRADE-BRANDS. Trade-brands may be considered subject to the limitations, and under the conditions, discussed in a following paragraph entitled "Intangible Property."

FRANCHISE OF A CORPORATION OR PARTNERSHIP. The franchise of a corporation or partnership may be considered subject to the limitations, and under the conditions, discussed in the following paragraph entitled "Intangible Property."

INTANGIBLE PROPERTY. The law provides that goodwill, trade-marks, trade-brands, the franchise of a corporation or partnership, or other intangible property, may be included as invested capital if the corporation or partnership made payment in good faith therefor, specifically as such, in cash or tangible property. This is one of the many obscure provisions of the law and it is difficult to understand the reason for inserting the language, since, if payment is made for such intangible property with cash or tangible property, it must either be cash or tangible property contributed by the stockholders or members, or cash or tangible property borrowed. In the former case the consideration has already been included as invested capital and in the latter case the law expressly provides that borrowed money or property cannot be so included. The law further permits such intangible property to be considered in ascertaining invested capital, when paid for in stock or shares of the corporation or partnership, under the following conditions and limitations: (a) the intangible property must have been purchased in good faith prior to March 3, 1917, and the stock or shares in payment thereof must have been issued prior to March 3, 1917, (b) the amount

of shares which may be considered as having been issued for such intangible property is an amount not to exceed (on March 3, 1917) 20% of the total interests or shares of the partnership or corporation, (c) the amount which may be included as invested capital is the actual cash value of such intangible property at the time of such purchase limited, however, in case of issue of stock therefor to an amount not to exceed the par value of such stock. It will be noted from (a) above that good-will, trade-marks, trade-brands, franchise of a corporation or partnership, or other intangible property paid in for stock or shares may not be considered in determining invested capital if such property was paid in on or after March 3, 1917. The permission applies only to transactions which took place prior to that date. It should also be noted that if the property was paid in prior to that date, but stock or shares were not issued until on or after that date, the transaction cannot be considered, if the law is to be literally construed. The provision stated in (b) above, apparently means that if a corporation or partnership issued more than one-fifth of its stock or shares for such intangible property, the invested capital may be computed only on such proportion as is represented by one-fifth of the stock or shares. If, for instance, a corporation had, on March 3, 1917, twofifths of its stock issued for such intangible property, only one-half of the actual cash value (at the time it was paid in) of such intangible property can be considered as "invested capital." The statement under (c) above, indicates that in this case, as in all others, the value of the property, for which shares or stock have been issued, must be taken as of the time the property was acquired, and the stock issued therefor, and, further, that in the case of corporations such value cannot exceed the par

value of the stock issued therefor. The law makes no provision for cases where the contributor may have paid large sums of money for intangible property, such as rights, franchises and good-will. As an illustration, an individual may have purchased a trade-mark, paying therefor the sum of $100,000. If he thereafter forms a corporation and transfers the trade-mark to it, in exchange for $100,000 of stock, the corporation may not, under the language of the law, claim any amount as invested capital with respect thereto. On the other hand, if the same individual had, prior to March 3, 1917, transferred the same trade-mark or trade-brand to a small corporation, merely as a matter of convenience, in exchange for the issue to him of $1,000 of capital stock, the corporation would not be permitted to claim more than $1,000 as invested capital. If the individual uses the trade-mark in his business, without incorporating the business, or taking in a partner, he may claim $100,000 as invested capital. Examples of this sort can be multiplied indefinitely to show the imperfections of the statute.

7744

Surplus and Undivided Profits. In addition to the cash and property paid in by the stockholders or members, a corporation or partnership may include the amount of "paid in or earned surplus and undivided profits used or employed in the business, exclusive of undivided profits earned during the taxable year. Surplus and undivided profits may be included as "invested capital," if paid in by the stockholders or members, that is, contributed in cash or tangible property, for which no stock or shares have been issued. It seems, for instance, that if tangible property has been "paid in" to a corporation, having an actual cash value at the

44 Section 207a.

time of such payment greatly in excess of the stock issued for it, an amount equal to the par value of the stock will be considered as capital paid in, and the excess as surplus paid in. Earned surplus is that part of the surplus which has been accumulated by retaining in the business a part of the earnings of any year. The amount of such surplus is a question of fact to be determined in each particular case. The amount of earned surplus of any year since January 1, 1909, will probably be held to be the amount of net income, shown by the return of net income of the corporation, which has not been distributed in the form of dividends to the stockholders. If in any of those years amounts have been charged to expense, which should have been charged to capital, the corporation may perhaps be permitted to reopen its books, make the proper entries and file amended returns. With respect to the years prior to January 1, 1909, it seems that amounts which should actually have been charged to capital may be considered as earned surplus employed in the business, provided proof of that fact can be produced.

Surplus and

USED OR EMPLOYED IN THE BUSINESS. undivided profits must be used or employed in the business in order to be considered as invested capital. Since the law expressly provides that a corporation or partnership shall be deemed to be engaged in business, and all trades and businesses in which it is engaged shall be treated as a single business, and all its income from whatever sources derived shall be deemed to be received from such trade or business, it would seem to follow that if surplus and undivided profits are invested in any way to produce "net income" within the meaning of this law, such surplus and undivided profits are used and

45 Section 201.

employed in the business. For example, if the surplus and undivided profits are invested in obligations of the United States, or bonds (other than state, municipal or other bonds, the interest of which is not included in "net income") it should be considered as employed in the business. The criterion seems to be that if income from the asset in which the surplus or undivided profits are invested would be included in the return for the purpose of this tax, the surplus and undivided profits are "used and employed in the business," whether or not any income is actually derived from the asset. The difficulty which arises is to earmark the capital, surplus, undivided profits and borrowed money of a corporation in order to determine whether or not it is the surplus or borrowed money which might be employed in assets that cannot be included as "invested capital." For instance, a corporation may have a capital stock of $100,000, surplus and undivided profits of $100,000 and a bond issue of $100,000. Its assets may consist of property and plant which cost it $100,000, taxable bonds which cost it $100,000 and stock which cost it $100,000. It cannot be said that either the capital, surplus or borrowed money is invested in any one of these forms of assets. The courts have held that capital or surplus cannot be earmarked, and each form of asset contains, in equal proportions, the capital, surplus and borrowed money of the corporation. Therefore, it would seem that only twothirds of the surplus is used or employed in the business of the corporation and one-third of the capital is invested in the stock. Hence, only two-thirds, or $133,333, of the capital and surplus is "invested capital." If, on the other hand, the borrowed money was used originally for the purchase of the stock, and it is held by the Treasury Department that the fund can be earmarked, the cor