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Annuities and other amounts received, not arising through the death of the insured, under a life insurance, endowment, or annuity contract, and not in excess of the consideration paid, are now non-taxable; and the recipient is not restricted to the insured (Art. 47).

Previously it had been held that an annuity received by B from a matured policy on the life of A, A having paid the premiums, was taxable income without allowance for amortization of the value of the annuity or for premiums paid (S. O. 160; I. T. 170 and 1108 overruled; S. M. 3434; I. T. 2183). Other matters relating to insurance receipts will be found on page 153.

Under the Treasury Department's interpretation of the 1918 Revenue Act, taxes paid by a corporation in connection with a tax-free covenant bond1 were regarded as additional interest received by the bondholder. These are specifically exempted commencing with the Revenue Acts of 1921 and 1924, effective from January 1, 1921 (Sec. 234 (a) (2)).

Interest on stock subscriptions is to be treated as interest and not as a dividend even though applied as a credit to the subscription account (I. T. 1334; S. R. 2294). Interest on a deposit in a mutual savings bank having no capital stock was also regarded as interest rather than a dividend (I. T. 1461). The nominal rather than the effective rate of interest is taxable income (O. D. 622). Instalments received in connection with a sale of land prior to 1913 were not taxable, but interest accrued and received thereafter was taxable (O. D. 646). Accruing interest on an investment bond is taxable in the year received or may be reported yearly in accordance with the redemption value of the bond (I. T. 1684). If the books are on a cash basis, interest due added to a renewal note is not income (4 B. T. A. 317). Interest on a tax refund is taxable (I. T. 1748).

The question of when interest is taxable is well illustrated in the customary forms of bank discount. The rule of the Department as expressed in S.M. 3820, which relates to banks, is that

1 Bonds with a tax-free covenant clause; that is, bonds where the agreement with bondholders is to pay, up to a certain percentage, the income tax which might be imposed on the interest received. See under "Withholding," Chapter XXV.

where the bank books are on a cash basis the discount on a commercial loan is not income until the note is paid; on the accrual basis the income should be taken up as earned. Where mortgage notes are purchased by a bank at a discount, partial payments should be divided as between interest and principal and the latter prorated between (a) the amount paid by the bank for the notes and (b) the excess of their face value over the amount paid, the earned discount as thus computed being income. Commissions on interest-bearing real estate loans are income when the loans are made because (a) they are customarily added to the notes or deducted from the money paid, (b) they represent services rendered in negotiating the mortgage, and (c) they are not canceled, as interest is canceled, if the notes are paid before maturity (S. M. 3820). Since the right to retain the commission is not dependent on subsequent expenses, the commission cannot be deferred, although future expenses may be incurred (G. C. M. 222). For cases on tax-free interest, see page 154. 3

RENTALS AND LEASEHOLDS

Rentals from property of various kinds are gross income from which the necessary expenses of maintaining the property may be deducted. Expenses of the lessor to be paid by the lessee must be included in the gross rental income of the lessor, but may be deducted if they are allowable deductions (Art. 547). A lessor must also report the present value of improvements made by the lessee which are to remain on the property after the lease expires. Under an old rule, income from this source accrued to the lessor at the time the lease expired, but this was reversed in a court decision (Cryan v. Wardell, 263 Fed., 248). As a result, Article 48 was modified, making the present value of improvements taxable to the lessor when erected by the lessee and upon passing of title. Or the lessor may report each year during the life of the lease a proportionate part of the depreciated value at the end of the lease. Premature termination of the lease will give rise to additional income to the extent of the unreported value of the improvements; destruction of the property occasions a deduc

tible loss in an amount equal to that already included as taxable income, less insurance received and any salvage values remaining. (Art. 48).

An illustration of "present value" of improvements has been given by the Treasury Department. A in 1915 leased land to B for 20 years, B in part consideration agreeing to construct a building thereon. The building, costing $50,000, was completed in 1920 and was expected to last 25 years, i. e., 10 years after the expiration of the lease. The annual depreciation at $2,000 (B can deduct 1/15 each year) would amount to $30,000 in 15 years, leaving a depreciated value at that time of $20,000. It is conceived that the present value of $20,000 (which would be around $10,000) is taxable income to A in 1920. After 1935 A can deduct for depreciation $1,000 annually, assuming the present value is $10,000. No adjustment need be reported for the discounted difference. Any improvements during the period of the lease will be similarly computed and added to A's income. If the improvement expires before the lease, or has no value in 1935, no income need be reported in 1920 (Mim. 2714). Payments on a 99-year lease with an option to purchase after 50 years at a price equal to one-fourth the annual rental was regarded as rent because evidence of a sale was lacking (I. T. 1819).

Cryan v. Wardell applies only where the life of the improvements exceeds the life of the lease; where they are less, there is no income to the lessor until he comes into possession of them on the cancelation of the lease (4 B. T. A. 756).

Leasehold value should be computed by ascertaining the present worth of theoretical rentals in excess of actual (3 B. T. A. 1099). Oral testimony as to March 1, 1913, values of a leasehold, especially where a portion of the value arises from speculative future worth, was held more evidential than Hoskold's formula (4 B. T. A. 933).

The sale of a leasehold held over two years could not be considered a capital gain and taxed under Section 206; a leasehold was considered the personal property of an individual (I. T. 1362); however, a lease held for business purposes is subject to the capital gain section.

Loss of rent is not a deductible loss unless the books are kept on the accrual basis and the rent has been included as income (O. D. 486). No taxable income accrued to a railroad by crediting income with rentals for the temporary use of its own equipment for construction purposes. The amount of the rental was

likewise excluded from construction costs for purposes of arriving at invested capital (O. D. 811).

Royalties withheld by a lessee on properties under litigation were income to the lessor in the year in which the case was settled (I. T. 1212).

FOREIGN EXCHANGE

No definite rules are laid down in the law or regulations regarding the conversion of income from foreign branches, or from foreign transactions, but the appended quotations from Treasury Department rulings are suggestive.

A domestic corporation had a branch office in London which kept its books in English currency, rendered a report at the end of each year, and during the year remitted any surplus profits to the home office. To arrive at the net profit to the home company, from the total profits of the branch, remittances thereof (all expressed in terms of English currency) were deducted, and the balance of the net profits on hand were converted at the prevailing rate of exchange at the end of the year. The converted balance plus the remittances converted at actual rates gave the taxable income expressed in American money for the year (O. D. 550 and 618). A corporation bought sterling exchange, remitting it to a London representative to use in purchasing raw materials. The Department ruled that the corporation had sustained no deductible loss at the close of its taxable year on the unexpended credit abroad on account of a lower exchange rate (O. D. 940). The cost of goods purchased abroad priced in terms of foreign currency was the cost of the remittances covering the payment (O. D. 498). A domestic corporation bought substantially all of its raw material from its French stockholders. In making credit or debit entries the amounts were entered in francs and then in dollars converted at the current rate on the day of the transaction. The company in reporting income had converted the entire amount of francs due French interests into dollars at the rate prevailing at the end of the year, while the proper method was held to be that income should be reported on the basis of dollars converted on the date of the transaction. If the amount due the French stockholders at the end of any year showed a debit balance due to exchange rates, that amount should have been applied against the portion of the debt which was longest outstanding and the difference in the exchange rates was taxable income or deductible loss (O. D. 590). Taxpayers trading or manufacturing in

foreign countries have been allowed to convert their current assets, less current liabilities payable in foreign currency, at the current rate of exchange at the end of the year, or at any rate less favorable where the circumstances would seem to warrant (A. R. R. 15 and O. D. 489). A taxpayer owning foreign securities received credit abroad expressed in foreign money for the interest as it accrued. The taxable income on the transaction was the amount expressed in terms of dollars converted on the date the credit was given at the then current rate of exchange. If a draft was mailed for the interest, the taxable income was determined by the rate of exchange on the date the draft was received. Where the purchase and sale of foreign securities resulted in a gain as computed in terms of the currency of that foreign country but in a loss when computed in terms of United States money, the result in terms of United States currency was the deductible loss (O. D. 809). A dealer in foreign exchange who was regularly engaged in the purchase and resale of foreign money to customers, may inventory his unconverted exchange at cost or market whichever is lower. This rule does not apply, however, to an individual purchasing foreign money for investment or speculative purposes; a loss or profit therefrom can be reported only when his purchase is disposed of (O. D. 834). In general, income should be expressed in United States money at the exchange rate at the date of receipt (O. D. 419, 559). Commissions paid in a foreign country to Americans should be reported by both the corporation and the individual at the rate existing on the date paid or credited to the account (O. D. 1066).

Generally, a loss on foreign exchange is not deductible until realized (O. D. 764); 1 B. T. A. 1077), but if it has been used to purchase merchandise, any decline to the date the merchandise was purchased may be claimed as a loss (1 B. T. A. 1051). Standing as an asset in the books of a corporation not a dealer, foreign exchange is not subject to the rule for valuing inventories (1 B. T. A. 1141). Through the operation of the Dawes plan, paper marks of the German Reichsbank were redeemed at the rate of one trillion paper marks for one gold mark; the resulting loss could be claimed in a 1924 return (I. T. 2154), but not a loss in value of Hungarian crowns, because the Hungarian Government has no scheme of redemption (I. T. 2227).

The following references contain approved quotations of values of foreign money with respect to the dollar at the close of various periods: Ó. D.'s 551, 772, 803, 876, 898, 913, 996, 1027, 1036, 1052, 1053, 1065 and 1137; I. T.'s 1202, 1315, 1324, 1325, 1482, 1483, 1495, 1544, 1809, 1908, 2138, and 2255.

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