RULING. Receipt is acknowledged of your letter of March 25, 1919, in which you state that the various subsidiaries in which the Company is affiliated with Company has on stock directly or owns the stock of the company which does own all the stock of such affiliated company. The hand an investment in Liberty bonds amounting to $2,345,000 of the second, third and fourth issues. You inquire if the Company may apportion the Liberty bonds held by it among its several subsidiaries in order to determine the total exemption allowable for purposes of a consolidated return. In reply you are advised that in cases of consolidated returns, affiliated corporations are treated as if they were one corporation and the tax is based upon the consolidated income and the consolidated invested capital of these corporations. Whether the parent company owns the bonds or apportions them among its subsidiaries, makes no difference in the amount of exemption allowable in cases where consolidated returns are required, as such exemption is based upon the consolidated condition. (Letter, signed by Commissioner Daniel C. Roper, and dated April 5, 1919.) If the parent corporation should make a bona fide sale of bonds to the subsidiary corporations, then such corporations would be entitled to the exemptions consequent on the holding of the bonds purchased under the ruling of May 21, 1919, quoted on page 438. United States Obligations Owned by Non-Resident Aliens, Foreign Corporations, etc.11 In order to encourage foreign investors to buy and hold Liberty bonds, Congress provided in the Victory Liberty Loan Act that obligations of the United States shall be exempt from federal, state and local taxes while beneficially owned by nonresident aliens and foreign corporations, partnerships and associations not engaged in business in the United States. LAW. Section 4. That section 3 of the Fourth Liberty Bond Act is hereby amended to read as follows: "Section 3. That, notwithstanding the provisions of the Second Liberty Bond Act or of the War Finance Corporation Act or of "See Chapter XXXIII, “Non-Resident Aliens." any other Act, bonds, notes, and certificates of indebtedness of the United States and bonds of the War Finance Corporation shall, while beneficially owned by a nonresident alien individual, or a foreign corporation, partnership, or association, not engaged in business in the United States, be exempt both as to principal and interest from any and all taxation now or hereafter imposed by the United States, any State, or any of the possessions of the United States, or by any local taxing authority.15 15 Victory Liberty Loan Act, approved March 3, 1919, section 4. INCOME FROM RENTS Under each of the successive income tax acts rent has, in all cases, been made returnable as income subject to taxation. LAW. Section 213. . . . . the term "gross income" (a) Includes . . . . income derived from . . . . rent Income from rents may be reported on the accrual basis or on the actual receipt basis. If books of account are kept, all rents accrued, and believed to be collectible, should be reported. Any items found to be uncollectible may be deducted as losses in subsequent returns. If reporting on the accrual basis is not practicable or convenient, it is sufficient to return all rents received in cash during the tax year. The author has been informed that during 1919 some taxpayers were advised that rents should be reported as income only when collected in cash, but that all expenses, such as interest, insurance and repairs, should be claimed as deductions on the accrual basis. Such a method could not clearly reflect the true net income of a taxpayer. Therefore any taxpayer who followed such advice may expect to be penalized. Taxpayers who do not keep books will probably always be permitted to report on a cash basis, but no taxpayer can expect to be allowed to return his expenses on an accrual basis and his income on a cash basis. Permanent improvements by lessees.-It has been held that where improvements by a lessee revert to the landlord at the end of a lease, the value of the improvement is taxable to the landlord as the equivalent of additional rent. An old Treasury decision (T. D. 2442, February 6, 1917) specifically states that the landlord may not claim any annual depreciation during the lease term. The manner in which the tenant may charge off the cost of the improvements is made clear in the following regulations: REGULATIONS. When improvements made by a lessee become part of the real estate, the value of such improvements upon the expiration of the existing term of the lease is income to the lessor. In general, sums paid by a tenant for the use of property, although to another than the landlord, are properly to be regarded as rent and constitute income of the landlord. . . . . (Art 48.) . . The cost of erecting buildings or permanent improvements on ground leased by a taxpayer is additional rental and is therefore a proper deduction from gross income, provided such buildings and improvements under the terms of the lease revert to the owner of the ground at the expiration of the lease. In such a case the cost will be prorated according to the number of years constituting the term. of the lease. The lessee will not be permitted to deduct from gross income any depreciation with respect to such buildings, but the cost of incidental repairs necessary to keep them in an efficient condition for the purposes of their use may be deducted. If, however, the life of the improvement is less than the life of the lease, depreciation may be taken by the lessee instead of treating the cost as rent. . . . . (Art. 109.) The tendency of landlords is to overvalue the improvements reverting to them at the end of a lease. Usually they receive an obsolete building out of repair and unrentable. In case a lessor desires or is compelled to account to the Treasury for the improvements on his land, he should set up the cost to the tenant as ascertained and then write off the entire amount as depreciation. Then, if at the end of a lease a lessee relinquishes possession and the landlord acquires improvements of actual value, such actual value should be considered realized income and be reported for taxation. Up to the date of realization there has been no certainty of any gain or income which the income tax law reaches. It is possible that, under the procedure proposed in the foregoing suggestion, a landlord might in one year be compelled to return for taxation a considerable amount, which in fact had been accruing from year to year and if reported and taxed annually might have been taxed less in the aggregate than if reported in one lump sum. If a landlord so desired he would be permitted to return an estimated annual accrual, but this amount would be only a guess and not necessarily a safe guess. If a lease is renewed it is usual to revalue a property, so the ruling quoted above is not open to criticism when it insists that "the expiration of the existing term of the lease" is a suitable time to value the improvements for the purpose of taxation. Guaranteed dividends or interest as rental equivalent.It frequently happens that where one corporation leases the property of another corporation the lessee pays as rental a sum equal to the interest on certain securities or equal to a fixed dividend upon the capital stock of the lessor. The rental paid is a business expense of the lessee corporation and a rental income of the lessor corporation. The latter must so report the income even though the guaranteed dividends or the interest are paid directly to its stockholders. The following regulation summarizes previous rulings: REGULATION. Where a corporation has leased its property in consideration that the lessee shall pay in lieu of other rental an amount equivalent to a certain rate of dividend on the lessor's capital stock or the interest on the lessor's outstanding indebtedness, together with taxes, insurance or other fixed charges, such payments shall be considered rental payments and shall be returned by the lessor corporation as income, notwithstanding the fact that the dividends and interest are paid by the lessee directly to the stockholders and bondholders of the lessor. The fact that a corporation has conveyed or let its property and has parted with its management and control, or has ceased to engage in the business for which it was originally organized, will not relieve it from liability to the tax. While the payments made by the lessee directly to the bondholders or stockholders of the lessor are rentals as to both the lessee and lessor (rentals paid in one case and rentals received in the other), to the bondholders and the stockholders such amounts are interest and dividend payments received as from the lessor and as such shall be accounted for in their returns. (Art. 546.) |