of the premium should be carried into the expense account as one item.

A corporation issued $100,000 of its capital stock to pay for a leasehold having 31 years to run. The question arose as to how it should be treated in the accounts. If the value placed upon the leasehold was not excessive, the transaction was the same as if the corporation had sold its stock for cash and had then purchased the lease for cash. In that event it would have been proper to charge off each year as an expense one thirty-first of the amount paid.

Depreciation and repairs of buildings on leased lands.REGULATION. . . The lessee will not be permitted to deduct from the 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.)

Rentals paid by professional men and others.-Under the title "Business expenses of the professional man" (page 543) will be found a full discussion of this topic.

Business Expenses Distinguished from Capital Outlay

Organization and similar expenses.-The Treasury rulings forbid the deduction of attorneys' fees, accountants' fees, fees paid to state authorities and other expenditures usually grouped under the term "organization expenses." On this point the rulings are in direct conflict with good accounting practice.

REGULATION. Expenses of the organization of a corporation, such as incorporation fees and attorneys' and accountants' charges, constitute investments of capital and are not deductible from gross income. .... (Art. 582.)

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The first formal decision dealing with this subject, did not appear until June 11, 1917 (T. D. 2499). For text of decision see Income Tax Procedure, 1919, page 438.

The treatment of items of this type has been a problem much discussed by accountants, but the following may be taken as a fair reflection of present accounting practice:

If the expenses incurred in the organization of a company, such as incorporation fees, legal, engineering and other expenses, engraving bonds and stock certificates, transfer fees and stamps, etc., were more than can fairly be charged into current expenses, it was hitherto considered permissible to spread the charges over a term of years, preferably three, and not more than five.

In some respects sentiment is changing as to the wisdom of spreading these expenses over more than two years. The best practice is to charge off immediately everything which has no tangible or residual value. It is a fallacy to assume that stock certificates, incorporation expenses, etc., have any of the attributes of an asset, and so the sooner the cost appears in the expense account the better.

The old theory of deferring part of the charge to profit and loss was sound enough except that the rule has been abused, and we now find apportionments over five years or longer. In some cases all organization expenses, using the term in its broadest sense, are permanently capitalized. The author advocates charging off all such expenses as they are incurred.55

If the expenses are actual and are incurred in good faith, they constitute deductions which should be allowable for the period during which they appear on the books as charged to profit and loss. In the opinion of the author the direct invitation to capitalize items of this nature is unsound. If a corporation actually capitalizes the items, of course it must not claim credit for the deduction; but, if it follows proper and now almost settled corporate practice, this class of expenditures should appear in its books as ordinary expenses.

It is difficult to understand how the position may be maintained that organization expenses "constitute investments of capital." If state laws are complied with and the usual fees are charged and paid, certainly such expenses are necessary to the operation of the corporation. Corporations are penalized enough without adding another injustice.

The fact that the items are not recurring ones seems to

$5

Auditing, Theory and Practice (2nd edition), by R. H. Montgomery, page 345.

have had something to do with the decision. Anyone familiar with corporate affairs knows that thousands of items occur once only, but, nevertheless, are ordinary and necessary.

The Treasury may have borrowed the idea from Great Britain, where many such expenditures are held to be of a capital nature and not allowable as deductions under the income tax law. Assume, for the sake of argument, that incorporation expenses are capital expenses. The author contends that such items nevertheless are allowable deductions. Great Britain does not tax capital gains as our law does, and our courts will hardly hold that on one side our income tax law can tax capital gains while on the other side capital losses and expenses are not allowable deductions.

The author believes that the decision does not correctly interpret the law. If it does, the law should be amended.

It

The limitation on the credit for deduction of organization expenses can hardly be extended to reorganization expenses. may be that the latter are of the same nature as the former, but the regulation only covers organization expenses and should be construed strictly. Under the present law, which permits returns to conform to good accounting practice, expenses of this kind need not be capitalized.

Expenses incurred in selling capital stock.

REGULATIONS. . . . . If the stock is sold at a discount, the amount of the discount is not a loss deductible from gross income. .. (Art. 542.)

Any and all expenses incidental to or connected with the selling of the capital stock (common or preferred) of a corporation for the purpose of raising capital to be by it invested in property or employed in the business for which the corporation is organized are not an "expense of operation and maintenance" within the meaning of this title, and such expense is not an allowable deduction from the gross income, for the reason that such an expense is incurred in a capital transaction; that is, the raising of capital to be invested or employed in the business. ... (Reg. 33, 1918, Art. 145.)

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The comments on organization expenses apply to the

Page 574.

foregoing regulation. Of course, discounts on capital stock are not business expenses; but ordinary expenses of securing capital should not be capitalized. If it is not proper to capitalize an expense item it should be an allowable deduction as a

business expense.

REGULATION. A holding company which guarantees dividends at a specified rate on the stock of a subsidiary corporation for the purpose of securing new capital for the subsidiary and increasing the value of its stock holdings in the subsidiary may not deduct amounts paid in carrying out this guaranty in computing its net income, but such payments may be added to the cost of its stock in the subsidiary..... (Art. 582.)

Assessments on stock. The following ruling holds that voluntary assessments paid by security holders are not deductible by them as business expense:

REGULATION. . . . . Amounts to be assessed and paid under an agreement between bondholders or stockholders of a corporation, to be used in a reorganization of the corporation, are investments of capital and not deductible for any purpose in returns of income. . . . An assessment paid by a stockholder of a national bank on account of his statutory liability is similarly not deductible. . . . (Art. 293.)

An answer to a question in the Primer makes the general statement that "assessments made by a corporation on its capital stock are regarded as further investments of capital and do not constitute an allowable deduction in the return of the individual."57

If the assessments result in losses, credit may be claimed for the payments. If sustained prior to 1918 the deductions will be subject to certain limitations."

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In another answer, the Primer states that in the case of a mutual irrigation company, "assessments in proportion to stockholdings merely to raise funds to keep the irrigation system in usable condition and not to make extensions or betterments" may be deducted.59

Income Tax Primer, 1918, question 70.

See Chapter XXVII, "Deductions for Losses." "Income Tax Primer, 1918, question 71.

Deferred charges-advertising, etc.-It has been the custom of some concerns to spread extraordinary expenditures over a period of years. Where the future will assuredly receive some benefit therefrom, the policy is sound enough. (See "Organization and similar expenses, etc," page 574.) But any doubt should always be settled in favor of an immediate absorption. If these expenditures are deductible at all, the proportion actually charged to profit and loss is the only part which should be deducted in the income tax return. In other words, it would be improper to deduct all expenditures in one year if in the books of account a proportion thereof was deferred to later periods.

Repairs and depreciation.—

REGULATION. The cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as expense, provided the plant or property account is not increased by the amount of such expenditures. Repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of the property, should be charged against the depreciation reserve. .. (Art. 103.)

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The tendency of some inspectors is to question deductions for repairs on the theory that the usual depreciation allowances include ordinary maintenance. The law permits deductions for maintenance and operation in addition to depreciation. The necessity for allowing both claims is very well expressed in a recent decision,61 The court said:

DECISION. It will thus be seen that the deductions allowed are to include not only ordinary and necessary amounts actually paid out in the operations of the property, but also the amounts paid out in the maintenance thereof, and in addition a reasonable sum for depreciation, if any. Now, the operation of a business or property includes payment for labor and materials which go into the actual operation thereof, while maintenance means the upkeep or preserving

See Chapter XXIX, "Deductions for Depreciation."

"The San Francisco & Portland Steamship Co. v. John J. Scott, Collector of Internal Revenue, etc., and August F. Muenter, 253 Fed. 854. (T. D. 2773, November 8, 1918.)