of the gain or profit to the lessor at the termination of the lease is the difference between the cost of the building or improvement so made by the tenant and a reasonable allowance for depreciation during the period. of its life under the lease.2

Lessor Corporations. Where a corporation leases all of its property to another and specifies that the consideration therefor shall be paid direct to its stockholders and bondholders or creditors the lessor corporation is, nevertheless, held to be the proper recipient of the income and must report, as rent, the amount so paid to its stockholders, bondholders or creditors by the lessee.3

Payments by Tenant on Behalf of Landlord. Where under the terms of a lease a tenant pays taxes or interest, or makes any other payments for and on behalf of the landlord, the amount of such payments constitutes income to the landlord and should be reported by him as such. The theory covering these transactions is that the tenant. is acting merely as agent for the landlord in making such payments. The expenses are the landlord's, which he may deduct from his net income, and the amounts used to defray such expenses must be included by the landlord as his net income. Such payments may be deducted by the tenant as rent in the year in which they are paid.

2 T. D. 2442. It necessarily follows that the tenant may consider the cost of the building as a part of his rental payments and may deduct such amount as an expense, pro-rating the original cost over the number of years constituting the term of the lease. See Chapter 28.

3 For a further discussion of this subject see sub-heading entitled Lessor and Lessee Corporations in Chapter 12,

Receipt of Rent in Kind. Where rent is received in the form of produce, as for instance, a share of the crops of a farm, the amount realized on the sale of such share must be included as income in the year in which the share is disposed of or reduced to money or its equivalent. Where board or lodging is given as the equivalent of rent, the value of such board or lodging is required to be included.4

4 See Chapter 16 for statement on receipt of income in kind or in the equivalent of cash.

CHAPTER 22

INCOME FROM INTEREST

Income derived in the form of interest is taxable in the hands of citizens and residents and domestic corporations, whether received from debtors in this country or debtors in foreign countries. Interest is taxable in the hands of non-resident aliens and foreign corporations when derived from interest bearing-obligations of residents, corporate or otherwise.1

Interest Exempt from Tax. The Act expressly provides that interest upon the obligations of a state, or any political subdivision thereof, or upon the obligations of the United States (with certain exceptions noted below), or its possessions, or securities issued under the provisions of the Federal Farm Loan Act of July 17, 1916, shall be exempt.

INTEREST ON OBLIGATIONS OF THE UNITED STATES. The interest received on obligations of the United States is exempt in the case of all obligations issued on or before September 1, 1917. In the case of obligations issued after that date the interest is exempt only if and to the extent provided in the Act authorizing the issue thereof.2

1 Act of September 8, 1916, §1 (a).

2 Under earlier income tax laws interest upon the obligations of the United States was expressly included as taxable income. (See Act of March 2, 1867). Under the 1909 Law the Attorney

3

SECOND LIBERTY LOAN BONDS. The Act authorizing the issue of the Second Liberty Loan Bonds provides that the bonds and certificates issued thereunder "shall be exempt, both as to principal and interest, from all taxation now or hereafter imposed by the United States, or any State, or any of the possessions of the United States, or by any local taxing authority, except (a) state or inheritance taxes, and (b) graduated additional income taxes, commonly known as surtaxes, and excess profits and war-profits taxes, now or hereafter imposed by the United States, upon the income or profits of individuals, partnerships, associations, or corporations. The interest on an amount of such bonds and certificates, the principal of which does not exceed in the aggregate $5,000, owned by any individual, partnership, association, or corporation, shall be exempt from the taxes provided for in Subdivision (b) of this section." It will be noted that bonds of this issue are not subject to the normal tax nor to the income tax of 6% if held by corporations. Where a husband and wife each own in his or her own right bonds of this issue not exceeding $5,000, each is entitled to exclude the income therefrom in computing the tax on their joint incomes. Minor children having separate estates are also each entitled to the same exemption. A taxpayer holding bonds and certificates of indebtedness issued under this Act is en

General held that interest on National Bonds should be included as income of corporations, since the tax was not a tax on property, but a tax on the privilege of carrying on business. (28 Op. Atty. Gen. 138).

3 Act of September 24, 1917 (Public No. 43), 87.

4 Letter from Treasury Department dated October 8, 1917; I. T. S. 1917, ¶ 2439.

titled to the exemption on $5,000 of his aggregate holdings, not on $5,000 of each class of obligations.a

OBLIGATIONS OF THE POSSESSIONS OF THE UNITED STATES. Interest paid on the obligations of possessions of the United States is exempt. Interest on the obligations of the territories, or political subdivisions thereof, can be considered as exempt only on the ground that the territories are possessions of the United States, since the law does not expressly include territories in the exemption provision.

INTEREST ON THE OBLIGATIONS OF A STATE. The same principle which denies to a state power to raise revenue by taxation on federal property, or sources of revenue, or means of carrying on its duties, forbids taxation of state revenue for federal purposes.5 Therefore the United States has no power under the Constitution to tax either the instrumentalities or the property of a state. A municipal corporation is a portion of a sovereign power of a state and is not subject to taxation by Congress upon its municipal revenue." But the exemption of state agencies does not extend to those used by the state in carrying on an ordinary private business. Interest on the obligations of a state is, therefore, expressly exempt. The 1909 Law, however, being an excise tax and not an income tax, was valid although measured by income which included interest from state securities.

4a T.D. 2585.

5 Collector v. Day, 11 Wall. 113; Ambrosini v. U. S. 187 U. S. 1. 6 Pollock v. Trust Company, 157 U. S. 429, 584.

7 U. S. v. Railroad Company, 17 Wall. 322.

8 South Carolina v. U. S. 199, U. S. 437.

9 Flint v. Stone Tracy Co., 220 U. S. 107.

F. I. Tax.-17