taxable income is $25,000. Hence the effect of excluding interest paid as a deduction is to tax more income than has been received. The asset which otherwise would be inadmissible is therefore admissible in its entirety. In Case 2 the taxable income is also $25,000, $4,000 in excess of the net income which would be taxed if not related to taxfree bonds. This $4,000 answers the description (Sec. 325(a)), "part of the interest derived from such assets in effect included in net income because of the limitation on the deduction of interest under Section 234(a) (2)." The interest received was $5,000; therefore $1,000 of the gross income of $30,000 derived from the asset is really the only portion which is actually tax-free. It follows that 29/30 of the otherwise inadmissible asset becomes admissible. Following the above plan we may arrive at real inadmissibles for tax purposes. The ratio obtained by dividing the average inadmissibles during the taxable year by the average of all assets is applied in reduction of the invested capital after giving effect to additions, deductions, and changes during the year as previously described. As stated before, the reason for this is that if the income is not taxed the taxpayer should not be allowed the benefit of that portion of the principal which is in invested capital. ' 1 Average inadmissibles and the average of all assets are obtained by taking one-half of the total at the beginning and at the end of the taxable year, unless some such averaging method as already described is applied by the taxpayer or is directed by the Commissioner. War Finance Corporation bonds are inadmissible assets to the extent of the first $5,000 held, inasmuch as this sum is the only portion free from tax under Section 16 of the act creating them dated April 5, 1918 (O. 781). Federal Reserve bank stock is an inadmissible asset in the hands of member banks (O. D. 81). Federal land bank bonds are also inadmissibles (O. D. 1069). An investment in the stock of a cooperative water-power company (S. R. 2084) and in a joint power-producing company (3 B. T. A. 1 See also page 189. 1213), no dividends being payable on either stock, were held to be inadmissible. The entire holding in the stock of a foreign corporation should be included in invested capital if at no time during the year the corporation had income from within the United States (I. T. 1177, T. B. R. 67 and O. D. 305). Interest-bearing school warrants issued by a county of a state were held to be inadmissible assets; but where non-interest bearing and not discounted, being held merely for accommodation purposes, they were treated as admissible (O. D. 1096, O. D. 929 modified). Bonds issued by the Government of the Philippine Islands were inadmissible assets (O. D. 1057), and bonds of Porto Rico and Hawaii also fall into the same class (O. D. 86 and 1044). Inadmissible assets of a dealer in securities are subject to the same rules requiring pro rata deduction from invested capital as though they were owned by another type of enterprise (I. T. 1155; A. R. R. 6572); they should be averaged in total (1 B. T. A. 279). Where the entire amount of income on an inadmissible consists of profit from sale, the whole of the average cost of the asset becomes admissible (A. R. R. 7991). In computing the amount of inadmissible assets for the purpose of determining the average percentage, the total cost of Liberty bonds subscribed for, whether fully paid or not, should be included in admissible assets (O. D. 28). An interest in the assets of a dissolved corporation represented by stock should not be considered as an admissible asset after the date of dissolution, but should continue to be classed as an inadmissible asset until such time as the assets were actually distributed (I. T. 1434). Only the cost could be included in computing admissibles and inadmissibles when part of the latter became admissible through sale; any profit realized was current (I. T. 1536). In 1917, the purchases of inadmissibles during the year did not affect invested capital (I. T. 1796). XXIV INVESTED CAPITAL: REORGANIZATIONS-SPECIAL CASES-SUMMARY Reorganizations and invested capital. Reorganizations prior and subsequent to March 3, 1917. Special cases. Abnormal conditions affecting the income or invested capital of a corporation. Summary. IN computing the invested capital for the pre-war period, the law provided that if a corporation had acquired a business after January 1, 1911, the corporation was to be regarded as existing from the date of the inception of the prior organization. While this provision no longer has any bearing on the computation of taxes from 1919 to 1921, unless war contracts were worked on during the year, the principle was extended to corporations formed from January 1, 1918, to July 1, 1919; that is, such businesses (before being incorporated) could elect to be taxed as corporations on their net income earned between January 1, 1918, and the date of organization as a corporation, providing their net income for 1918 was in excess of 20% of their invested capital. A similar provision in the 1921 law extended the privilege to be taxed during 1921 as corporations to businesses incorporated within four months after the passage of the law (November 23, 1921). No corresponding section appears in the Revenue Acts of 1924 and 1926. A reorganization or transfer of property taking place after March 3, 1917, if 50% or more of the interest or control remained in the hands of the same persons, was looked upon as a continuation of the same business or ownership, individual, partnership, or corporation, and any asset taken over could not be given a value greater than its value for invested capital purposes (in case the old business was a corporation) or cost (individual or partnership), 265 plus improvements, less depreciation and other losses (Sec. 331; Art. 941). Inasmuch as this section was eliminated along with the entire excess profits tax title, it had no bearing on values for purposes of determining profit or loss on sales, depreciation, or losses. Where a reorganization was effected prior to March 3, 1917, in which one corporation changed its name and absorbed a second corporation, the assets of the first must be valued at a figure no higher than that allowed the old corporation, while the assets of the second corporation were valued at their fair market value at the time of the transfer (O. 872). A newly formed corporation took over the assets of a defunct corporation on condition and with the consideration that the new corporation pay the debts of the old; stock of the new company was sold for cash to raise working capital. It was held that only the proceeds from the sale of the stock could be included in invested capital (T. B. M. 49). In a reorganization after March 3, 1917, wherein a partnership was incorporated, assets not acquired for value by the partnership were disallowed as invested capital of the corporation (A. R. R. 393). A partnership was incorporated February 14, 1917, and additional capital in the way of land and buildings was contributed by the partners; the basis of value of these additional assets was their appraised value on the date of transfer computed by adding back depreciation to a December 22, 1919, appraisal (A. R. R. 390). A merger is defined as a combination of corporations whereby one corporation maintains its identity and the others lose theirs, while in a consolidation the identity of the constituent corporations is lost by the formation of a new and distinct entity (Sol. Op. 4). Renewal of a charter is not a reorganization (O. D. 930). The reorganization section does not relate to the computation of depreciation and depletion but only invested capital (O. D. 458). Reorganizations prior to March 3, 1917, are not subject to the same limitations as those following that date (A. R. M. 60; Sol. Op. 41). A partnership was incorporated in 1918, stock being issued covering built-up or gradually acquired good-will under the theory that additions in the way of actual betterments would be permitted; although disallowed, good-will set up on the books in 1900 after a partnership re organization but written off prior to 1918 could be again set up for invested capital purposes (A. R. R. 618). An individual business was transferred to a corporation, more than 50% of the stock being issued to relatives of the sole owner. that the ownership had changed (A. R. R. 645). It was held * of corporate ownership taking place in 1913 by order of a court, the stockholders remaining the same, was held to constitute the formation of a new enterprise and the fair market value at that time was properly included in invested capital in a 1917 return (O. D. 1097). "Control * * of 50% or more remains in the same persons, or any of them" (Sec. 331) does not confine the continuing control to the same owners; persons will include stockholders of corporations not affiliated. Further, the transfer of values without change therein required by Article 941 is inconsistent with the law where property has a cash value less than cost to the previous owner; the law merely states that no greater value will be allowed (L. O. 1081 and T. D. 3259). A reorganized corporation could not include in its invested capital any appreciation over the old balance sheet, but it was allowed to start a new taxable year and include the surplus at the reorganization date (T. B. R. 2). When a firm was reorganized from a partnership to a corporation subsequent to March 3, 1917, and less than a majority of its stock was transferred to prior owners but in effect all went to them and their nominees, so that they, for a time at least, owned the entire corporation, invested capital could not be raised (A. R. R. 409). A corporation organized during the year and as of January 1 taking over another business could not file a return for the full year (A. R. R. 467). A foreign corporation organized a domestic corporation to take over its local business and controlled over 50% of its stock. The assets were valued at their cost to the foreign corporation (O. D. 789). The provisions relating to reorganizations did not apply to any acts prior to the Revenue Act of 1918 (O. D. 783). A reorganization after March 3, 1917, did not require the use of cost values to the prior owner under the 1917 law, as it did in the 1918 law in case there was less than a 50% change in ownership (A. R. R. 285). The identity of the stockholders in a reorganization prior to March 3, 1917, did not destroy the fact that two separate entities existed. Therefore the assets should be valued at the amount paid for them in stock by the successor corporation and not the original cost which was higher (A. R. R. 761). A corporation amended its charter in 1911, and in 1914 changed the name and transferred its assets to a new corporation; for the valuation of assets the original cost of acquisition should be used, as no change in entity resulted (I. T. 1420). A corporation charter expired in September, 1917, and under the state laws it was allowed to continue until dissolution or reorganization, It reorganized later but no values greater than cost were allowed to |