but also by an amount equal to 5% of the average borrowed money during the period, the theory being that a fair return on tangible assets was 10% while money could be borrowed at 5% (3 B. T. A. 873).

A patent may be valued by using Hoskold's formula (2 B. T. A. 457)1.

1 Hoskold's formula is used to obtain the present value of tangible or intangible sources of income having a limited life.

Let

a=the fair present value of the total net income to be derived, the ascertaining
of which is the object of the formula.

b the total net book income which the property will produce during its useful life,
and which, therefore, must, within reasonable limits, be predeterminable.
c=the rate of return, based on a, which will be a fair annual return for "risk,"
i. e. business profit. In practical situations this rate varies between six and
twenty per cent.

d the rate of return, compounded annually, on the sinking fund theoretically set up
after allowing the fair return in c. The rate usually adopted is four per cent.

n the number of years over which the profits will be earned.

Or, if I be the total compound interest accruing in the sinking fund

observed that is the equivalent of the formula used in determining sinking-fund instalments. The computation may be greatly simplified, therefore, if compound interest or sinking fund tables are at hand.

A simple illustration will make clear the uses to which the formula may be put: What should a lessee pay for a three-year leasehold which will produce for him an annual gross rental of $1,200, assuming that he is entitled to a business profit of 10% on his investment in the leasehold, plus a sufficient return which when compounded annually at 4% will reimburse him for his investment when the lease expires?

Less-Business profit of 10% per year for three years on lessee's cash investment of $2,854.77 ..

$3,600.00

856.43

Balance of income, representing theoretical contributions to a sinking fund. $2,743.57
Which, per year, is...

$914.52

Good-will charged off by a bank in pursuance to an order from the Comptroller of the Currency does not give rise to a deductible loss (I. T. 1995); nor does good-will paid for a five-year interest in a Texas partnership where the partner was entitled to an accounting at the expiration of the agreement (I. T. 1802).

SALES OR PURCHASES OF OWN STOCK OR BONDS

If the capital stock of a corporation is sold above par or below, the premium is not taxable income nor is the discount a deductible loss. The fair value of the property contributed by stockholders constitutes the paid-in capital of the business (Art. 543). Stock donated for working capital purposes when sold is additional capital (Art. 544). A corporation repurchasing and retiring or reselling its stock realizes no taxable income or allowable loss (Art. 543). If a stockholder in a corporation which is indebted to him gratuitously forgives the debt, the transaction amounts to a contribution of capital to the corporation (Art. 49).

A different rule applies to a corporation's own bonds where the discount or premium is prorated over the life of

(Footnote continued from page 68)

An inspection of the formula will reveal that as c is decreased, or d increased, the capitalized value will increase. The Board of Tax Appeals has been criticized for using as low a rate as 4%, on the theory that business men rarely, if ever, invest their money with the expectation of so small a return. Again, "paid-in values" or "fair market values" at March 1, 1913, or any other date are questions of judgment, it is argued, rather than formulas; and when Congress put these words into the law it did not intend that the aid of mathematics would have to be invoked.

Yet it is believed that the underlying idea in Hoskold's formula is a sound one, however strongly one may wish to criticize the rates applied in particular cases. The formula, or its equivalent, has been in use for years in computing the values of leaseholds, and while its application to patents and other intangibles is decidedly new, the necessity of a proper allowance for risk, interest, and a return of capital is the same in each case, provided the future income is definitely limited and can be reasonably forecasted. Risk and "pure profits" make up the larger percentage; and where the compensation for risk must be high, the capitalized value of the property, tangible or intangible, will be correspondingly less, assuming the same cash income from the property. Where the risk is a constant and the demand for capital great, present values of sources of terminable future income, such as leaseholds or patents, rise in accordance with the expected increase in interest rates as the invested capital is converted and put to other uses. These contrary effects of risk rates and interest rates are reflected in Hoskold's formula and justify its continued use.

the bonds as additional interest or as a reduction of the interest charge. A profit or loss may arise upon retirement before maturity; to determine the value equivalent to "selling price," the premium or discount remaining unamortized at the time of repurchase should be added to or subtracted from the par value. A corporation may thus have a taxable gain or a deductible loss from transactions in its own bonds in the same way as if the bonds were those of another corporation (Art. 545), except that the discount or premium on the bonds owned, obligations of another corporation, cannot be amortized.

No deductible loss arises in connection with the sale by a corporation of its own stock, commissions of a reasonable amount being regarded as a capital expenditure (T. B. R. 40), but interest received by a corporation from subscribers on their unpaid subscriptions was looked upon as being taxable income (L. O. 1035). Interest paid on subscriptions is deductible to the corporation, not being a transaction with a stockholder (I. T. 1334). Expenses of issuing additional stock, including commission paid to a salesman (A. R. R. 6048), and of retiring stock (O. D. 852) are capital expenditures and cannot be claimed as a deduction. A reduction in salaries due officers, when accepted by the officers, was held to be a capital transaction without taxable income arising to the corporation (O. D. 1034).

Sales of defaulted stock do not give rise to income (3 B. T. A. 1178), nor does stock surrendered to make good an operating deficit (S. M. 4447).

Discount and expenses incurred upon the sale of serial bonds should be prorated equitably as between the various series (O. D. 936); if bonds are retired before maturity at a discount and were originally sold for par, a taxable profit arises in the year of retirement (A. R. R. 545). Where discount had been charged off prior to the maturity of bonds a corporation was allowed to file amended returns (O. D. 111), and a railroad was required to prorate bond discount over the life of the bonds although the I. C. C. classification permitted an earlier deduction (I. T. 1962). This rule probably represents the present attitude of the Department, rather than A. R. R. 394 (see page 253).

Repurchase of bonds by a sinking-fund trustee, although the bonds may not be immediately retired, should be accounted for as

though the corporation itself had conducted the transaction (see page 137). So-called "treasury" bonds should be carried at par, and, if sold again, the discount or premium thereon should be spread over their remaining life.

VI

INSTALMENT SALES-CONTRACTS

LIQUIDATIONS INVOLUNTARY CONVERSIONS GIFTS

Profits from instalment sales taxable when realized. Three kinds of instalment sales. Computation of instalment income. The 25% limitation. Reporting profits twice. Evidences of indebtedness. Other deferred payment sales. Repossession. Contracts. Profits of a retiring partner. Income of a liquidating corporation. Profits from appropriation by government and from casualty or theft. Property acquired by gift, devise, bequest, or inheritance, and transfers in trust.

DEFERMENT of income where goods are sold on the instalment plan was recognized fully by the 1926 act for the first time. The 1921 (Sec. 202 (f)) and 1924 (Sec. 202 (e)) acts had merely permitted the instalment basis without defining it; the Department had permitted it since January 1, 1918. But the Board of Tax Appeals had held that the 1918 act did not vest the Commissioner with the necessary authority (1 B. T. A. 762), and Congress in the 1926 act made the new provision retroactive, unless the statute of limitations had run, to January 1, 1916 (Sec. 212 (d); 1208).

In general, although not defined by the law, an instalment sale takes place when a contract is entered into between buyer and seller (a) permitting deferred payments, usually weekly or monthly, covered by one or more notes which are a part of, or are separate from, the contract, (b) passing title with a chattel mortgage or other lien as security for the contract, or retaining title until a portion of or all the payments have been made, and (c) giving to the seller the right of repossession upon default in payment.

Three classes of instalment sales are defined by the 1926 act as follows: