at the beginning and end of the year and used in computing the net income of the year (see arts. 1611-1618);

(2) Expenditures made during the year should be properly classified as between capital and income; that is to say, expenditures for items of plant, equipment, etc., which have a useful life extending substantially beyond the year should be charged to a capital account and not to an expense account; and (3) In any case in which the cost of capital assets is being recovered through deductions for wear and tear, depletion, or obsolescence any expenditure (other than ordinary repairs) made to restore the property or prolong its useful life should be added to the property account or charged against the appropriate reserve and not to current expenses. (But see article 224.)

ART. 25. Accounting period.-The return of a taxpayer is made and his income computed for his taxable year, which means his fiscal year, or the calendar year if he has not established a fiscal year. The term "fiscal year" means an accounting period of twelve months ending on the last day of any month other than December. No fiscal year will, however, be recognized unless before its close it was definitely established as an accounting period by the taxpayer and the books of such taxpayer were kept in accordance therewith. The taxable year 1924 is the calendar year 1924 or any fiscal year ending during the calendar year 1924. (See section 200 (a) of the statute.) A person having no such fiscal year must make return on the basis of the calendar year. Except in the case of a first return for income tax a taxpayer shall make his return on the basis (fiscal or calendar year) upon which he made his return for the taxable year immediately preceding unless, with the approval of the Commissioner, he has changed his accounting period.

ART. 26. Change in accounting period.-If a taxpayer changes his accounting period he shall at least 30 days before the close of the proposed period for which a return would be required to effect the change, furnish to the collector, for transmission to the Commissioner, the information required on Form 1128. The due date of the separate return for such period is the fifteenth day of the third month following the close of that period. If the change in the basis of computing the net income of the taxpayer is approved by the Commissioner, the taxpayer

T

shall thereafter make his returns and compute his net income. upon the basis of the new accounting period. (See article 431).

ART. 50. When included in gross income. -Gains, profits and income are to be included in the gross income for the taxable year in which they are received by the taxpayer, unless they are included when they accrue to him in accordance with the approved method of accounting followed by him. (See articles 21-24.) If a person sues in one year on a pecuniary claim or for property, and money or property is recovered on a judg ment therefor in a later year, income is realized in that year, assuming that the money or property would have been income in the earlier year if then received. This is true of a recovery for patent infringement. Bad debts or accounts charged off subsequent to March 1, 1913, because of the fact that they were determined to be worthless, which are subsequently recovered, whether or not by suit, constitute income for the year in which recovered, regardless of the date when the amounts were charged off. (See articles 112 and 151.) Such items as claims for compensation under canceled Government contracts constitute income for the year in which they are allowed or their value is otherwise definitely determined.

UNITED STATES v. OREGON-WASHINGTON R. &

NAV. CO.

(Circuit Court of Appeals of the United States, (1918) 251 Fed. 211, 1 Am. Fed. Tax R. 989.)

Writ of error to a judgment overruling a demurrer to the answer, without leave to plead over, and dismissing the complaint. The complaint was for an excise tax against the defendant under section 38 of the Act of August 5, 1909 (36 Stat. 112, c. 6). The complaint alleged that on January 10, 1913, the defendant filed its report showing an income of $2,282,192.33, which was incorrect; the true income being $8,472,861.92. The relief demanded was for 1 per cent upon the difference, $6,190,769.57, amounting to $61,907.70.

The answer omitting denials, showed in substance as follows: That the defendant was organized in November, 1910, all its stock being held by the Oregon Short Line Railroad, itself a part of the Union Pacific Railroad system and controlled by that company. The Union Pacific Railroad caused certain

properties to be conveyed to the defendant by certain subsidiary corporations, which paid for them by a draft in favor of the sellers, drawn by the defendant and accepted by the Short Line. This draft the Short Line paid, and received back its proceeds from the selling corporations as dividends upon their stock, substantially all of which the Short Line held. The amount of these dividends was somewhat larger than the value of the property conveyed as it stood on the books of the selling corporations or as the value of their stock stood on the books of the Short Line. The amount of this difference was the sum here in question, $6,190,769.57, which therefore showed as a profit on the books of the Short Line.

The payment of the consideration by this acceptance the Short Line charged against the defendant, partly as payment for the stock of the defendant and partly as money lent it; the total sum paid by the Short Line being $50,000,000 for the stock and $50,450,000 as money lent. Early in 1911 the defendant delivered $40,000,000 of bonds to the Short Line, for which it received a credit of $36,000,000 leaving it indebted to the Short Line for money lent in the sum of about $14,450,000. To prevent an apparent profit to the Short Line from the transaction, it wished to reduce this indebtedness by the amount of that profit, and on June 30, 1911, released its debt against the defendant to the amount of $6,190,769.57. This release the plaintiff seeks to treat as a part of the defendant's income.

LEARNED HAND, District Judge (after stating the facts as above). The act in question has been authoritatively held to be an excise upon the right to do business in corporate form. Anderson v. Forty-Two Broadway Co., 239 U. S. 69, 36 Sup. Ct. 17, 60 L. ed. 152; Stratton's Independence v. Howbert, 231 U. S. 399, 34 Sup. Ct. 136, 58 L. ed. 285. As such the income is the measure of the tax upon the right, and not the property upon which the tax is assessed. If persons choose the corporate form for business, we think that the corporate income may be estimated upon the assumption that the form is to be regarded as the reality. Indeed, this is nearly a corollary from the premise that the tax is upon the right to do business in that form. We are not, therefore, disposed to say that a sole stockholder's release of a debt against the corporation is mere matter

of bookkeeping. As the stockholder views it, that is no doubt the case, at least while the corporation stays solvent; indeed, it is no more than if a mortgage were changed into a debt. Viewed from the corporation's side, we cannot, however, agree that the increased value of the stockholder's shares is to be deemed a charge upon the corporation equivalent to the canceled debt. His right as stockholder is, it is true, a chose in action; but it is, of course, not to be taken as a claim upon the corporation. when its net assets are in question, else it could never get any increase of assets, for shares are always proportionally increased in value as the assets increase. At least when we have, as here, a question turning upon the right to use the corporate form, we must treat the release as involving an actual addition to the corporate assets.

However, the tax, though it includes income "from all sources," nevertheless includes "income" only, and the meaning of that word is not to be found in its bare etymological derivation. Its meaning is rather to be gathered from the implicit assumptions of its use in common speech. The implied distinction, it seems to us, is between permanent sources of wealth and more or less periodic earnings. Of course, the term is not limited to earnings from economic capital; that is, wealth industrially employed in permanent form. It includes the earnings from a calling, as well as interest, royalties, or dividends, though in the case of corporations this may be of slight importance. Yet the word unquestionably imports, at least so it seems to us, the current distinction between what is commonly treated as the increase or increment from the exercise of some economically productive power of one sort or another, and the power itself, and it should not include such wealth as is honestly appropriated to what would customarily be regarded as the capital of the corporation taxed.

Now, it seems to us hardly arguable that the cancellation of the debt in question was not in the category of capital. The corporation had just commenced its business; the cancellation of the debt was a means of contribution to its capital account, quite as though the money had been contributed by the stockholder only to enhance the value of his stock. The financial relief, so given, will, it is true, be eventually reflected in the income, since the defendant will no longer be entitled under the act to deduct the interest on the debt; but that only brings

out more clearly its character as capital contribution. We regard the difference as precisely equivalent to the difference between the cancellation of a portion of the mortgage bonds and a cancellation of an equal proportion of their coupons. Common usage would, if we are right, unfailingly allocate the first as an increase in capital assets and the second as an increase in income. That, as we view it, is the proper test of the act.

Nor does Stratton's Independence v. Howbert, supra, look to the contrary. The court divided in that case upon the propriety of regarding as income the whole of each yearly extraction of minerals from a deposit necessarily limited in amount; but the decision proceeded upon the assumption that the common understanding of the term "income" did not cut so fine, but lumped together the whole gross output. Our present decision depends altogether upon the correctness of our own interpretation of the same common usage, when applied to a case like this.

The District Court refused to allow the plaintiff to plead over, upon the ground that the matter rested in its discretion and that the plaintiff had not asked for any exercise of that in discretion, but based its claim upon an absolute right. We agree that the cases are very rare in which a party should not be allowed to withdraw a demurrer, which is all that would have been necessary here; for no further pleading was proper, unless the defendant demanded it. Still the matter does lie in discretion, and the demurrant always accepts the risk of being taken at his word. There are certainly no grounds shown in the record which would justify our saying that the refusal was an abuse of discretion, at least in the face of the statement in the opinion that no such appeal to it was made.

The judgment is affirmed, with costs.

WARD, Circuit Judge (dissenting). I quite agree with the majority of the court that the credit given by the Short Line upon the defendant's indebtedness to it was a gift, and not a mere bookkeeping entry. It was not a return of capital, and I think was clearly a part of the defendant's gross income derived from all sources during the year in question. The meaning of the word "income" does depend upon its context; but this gift did come in during the year, was a part of the year's net income defined by the act, and I find no difficulty in calling