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SECTION 38.

Government would be the same as it is now, but as to a few corporations the tax would be somewhat less. It is urged, however, that the trifling loss to the Government would be more than compensated by the universal approval which would be extended to that taxing power, which, through a provision such as has been suggeated, indicates to those paying the tax that it desires to deal fairly with them.

In view of the fact that an income tax has been levied in England for more than 50 years it is obvious that valuable experience has been gained, of which we should take full advantage. We have among our members accountants who have had wide experience with the practical workings of the British laws, and their advice and suggestions are at your disposal.

In conclusion I suggest that wherever the machinery of Federal administration can coordinate with honest and efficient business methods simple justice requires that the laws specifying the machinery be skilfully drawn.

I would state, as I did when speaking before this committee on January 10, 1912, that the American Association of Public Accountants, from its close connection with all classes of business, is in a position to offer indispensable services and that we shall always be ready and glad to render every assistance in our power to further the preparation of efficient legislation.

We do not desire to appear as destructive critics, but as honest collaborators with those to whom the making of the laws is entrusted.

EVIDENCE OFFERED BY ARTHUr Young, CertIFIED PUBLIC ACCOUNTANT, CHAIRMAN OF THE COMMITTEE ON FEDERAL LEGISLATION OF THE AMERICAN ASSOCIATION OF PUBLIC ACCOUNTANTS AND PRESIDENT OF THE ILLINOIS SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS.

I appear before your committee for the purpose of offering for its consideration the advisability in levying any corporation tax of allowing corporations to make their annual returns based on their fiscal year, irrespective of whether that fiscal year may happen to be December 31 or not.

The main consideration in behalf of this policy is the fact that the Government will not suffer any diminution of revenue, while on the other hand it will confer great advantage to the business community.

A large number of corporations can close their year quite readily at December 31, but a very great number can not do so without great inconvenience and large expense. The main reason for this is that the taking of inventory is a matter of the utmost importance in ascertaining the profits. All conservative companies try to take their annual inventories at the time when their stock in process of manufacture, or their raw-material stock, is at the lowest amount, the reason for this being that a more accurate inventory can be taken and the possibility of errors be avoided. In addition many corporations that have to take inventories in the open air can not make their employees do this work in the severe weather and have to wait until a milder season of the year; other corporations are at their very busiest period at Christmas time and can not give the time to take the inventory without suffering severe financial loss. A factory has usually to shut down in order to take inventory. It therefore aims to do this at the slackest time of year.

It is suggested that the Government would be less liable to errors by the corporations if each corporation were allowed to close its year and take its inventory at the time of year when its stock is lowest and when for other reasons it has most time available for closing its business.

The above points can be illustrated from a few typical industries.

In the glass industry of this country, which is of enormous extent, it is necessary because of summer heat to close down the factories during the two hottest months of the year. Almost every one of these companies takes advantage of this opportunity to make up its inventory and close its business. Such corporations suffer loss and inconvenience by taking an inventory on the 31st of December. I believe many of them make their returns to the Government on an estimated inventory December 31. It would, of course, be much better to have their year close on the date of the actual inventory.

In the case of many blast furnaces, they have enormous stocks of iron ore on hand in wintertime. This is especially the case with blast furnaces situated on the Great Lakes, as they get their heavy supplies just before the close of navigation. The con servative corporations in this line of business prefer to take their inventories in spring, or summer time, when the stock of iron ore is practically used up and when the esti

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mates of amounts of iron ore on hand can be readily and accurately made. When many thousands of tons of iron ore are stacked up in the yards it is almost impossbile by measurement, owing to the difference in weight, to ascertain the exact value of the iron ore no matter how much this may be helped by chemical sampling. It, therefore, makes for accuracy if such concerns can take their inventories when their iron ore is

at the lowest.

Almost every department store in the country has its busiest time at the end of the year. They have just finished their Christmas trade and are preparing for their January sales, which open on the 2d of January. The practical result is that most of them take their inventory about February 1, just after the January sales are finished and before the spring trade begins. It is in many cases absolutely impossible for them to take an inventory on the 1st of January, therefore I presume in making their returns to the Government most of them must use estimated inventories. In this case it would also make for accuracy and certainly for the convenience of business if such corporations were allowed to choose their annual closing period themselves.

Similar considerations apply to the elevator and grain companies, especially in the northwest. They are in the middle of their busy season at December 31. Almost all of them find it advisable to wait until later in the year before taking stock and closing their business.

In the automobile business early winter is the busiest time for manufacturers. At December 31 their works are filled with half-manufactured goods and half-completed machines. If they are to ascertain their profits correctly it is almost necessary for them to wait as most of them do either until summer or autumn when they have few automobiles in process and can make up their inventory largely from raw material, the prices of which can be readily ascertained, and from fully manufactured machines. Many of them have in the busy season millions of dollars' worth of half-manufactured goods. If this has to be estimated for inventory purposes at that time wide errors are apt to arise.

Similar remarks apply to most of the agricultural implement makers of the country. Winter and early spring are their busiest times for manufacture, and it is often a hardship if they have to shut down their works and take inventory December 31.

In the lumber industry it is in many cases impossible to take an inventory in the depth of winter. The weather in many instances makes this physically impossible. The result is that according to the different climate in various parts of the country lumber companies take their inventories at varying seasons, some of them in summer and others later in the year. The arbitrary closing on December 31 in this industry works hardships in many parts of the country.

As regards railroads, there is a curious anomaly. The present corporation tax compels the railroads to close their year December 31, whereas the older authority of Interstate Commerce Commission has insisted upon June 30 being the time of closing for railroads. Much opposition arose against the Interstate Commerce Commission on this point, but in the past few years the commission has insisted upon railroads closing uniformly on June 30, which practice is now universal among railroads.

Express companies are in the same class as railroads. It would therefore appear that these two industries have to conform to two different governmental bodies. So far as I have learned no final decision has as yet been given as to which of them they have to obey. It would appear advisable to have uniformity in this respect.

The above instances are merely given as illustrations of a few of the classes of activities that are hampered by an arbitrary closing on December 31. In favor of allowing corporations, under proper regulation, to close their years at the period that suits them individually, it should be urged that thereby corporations will be saved much annoyance and large sums of money and that more accurate profits will be arrived at when the true inventories can be taken than when annual accounts are made upon estimated inventories of December 31.

The corporation tax is collected by the Government at a less expense than any other of our methods of taxation. It would seem that in levying this tax the Government should not make it a hardship on the people that pay it, but should take every reasonable means to have it paid with the least possible inconvenience and expense being imposed upon those who furnish this revenue for the Government.

SECTION 38.

FEDERAL CORPORATION TAX.

BRIEF ON BEHALF OF THE MANUFACTURERS' MUTUAL FIRE INSURANCE CO., RHODE ISLAND MUTUAL FIRE INSURANCE CO., STATE MUTUAL FIRE INSURANCE CO., MECHANICS' MUTUAL FIRE INSURANCE CO., ENTERPRISE MUTUAL FIRE INSURANCE Co., AND AMERICAN MUTUAL FIRE INSURANCE Co.

In the matter of House bill 28804, Sixty-second Congress, third session (by Mr. O'Shaunessy), to amend the second paragraph of section 38 of the act of August 5, 1909, so as to exempt unabsorbed premiums returned to policyholders from the Federal corporation tax.

I. QUESTIONS PRESENTED.

On August 5, 1909, President Taft affixed his signature to the tariff act of that date, by section 38 whereof an excise tax was imposed on corporations therein enumerated, measured by a percentage of net income. That law never contemplated the imposition of an excise tax on the unabsorbed premium deposits returned by mutual fire insurance companies to the policyholders on the termination of policies. Notwithstanding this fact, the Commissioner of Internal Revenue had insisted on imposing such taxes on such unabsorbed premiums, and the courts inferior to the Supreme Court of the United States have held that they are not taxable, and the Commissioner of Internal Revenue insists on his ruling until the Supreme Court of the United States decides to the contrary. In order to settle the question for all time and as legislation is better and cheaper than litigation, it is submitted the error should be corrected by legislation of the character contained in House bill 28804, Sixty-second Congress, third session, by Mr. O'Shaunessy, introduced February 19, 1913, or as found in section 120 of the act of June 30, 1864, and of the act of July 12, 1866.

II. A STUDY OF THE LEGISLATIVE HISTORY OF THE CORPORATION TAX ACT OF AUGUST 5, 1909, SHOWS THAT IT WAS NEVER INTENDED TO MEASURE THE EXCise corpoRATE TAX ON UNABSORBED PREMIUMS OR PREMIUM DEPOSITS OF MUTUAL FIRE INSURANCE COMPANIES RETURNED TO POLICYHOLDERS ON THE TERMINATION OF POLICIES.

On June 16, 1909, President Taft sent a special message to the first session of the Sixty-first Congress (S. Doc. No. 98, p. 2), wherein he said, among other things: "I therefore recommend an amendment to the tariff bill imposing upon all corporations and joint-stock companies for profit, except national banks (otherwise taxed). savings banks, and building and loan associations, an excise tax measured by 2 per cent on the net income of such corporations."

On June 29, 1909 (vol. 44, Congressional Record, 61st Cong., 1st sess., p. 3935) Senator Aldrich introduced a measure modeled on the lines recommended by President Taft. This became (in somewhat changed language) section 38 of the tariff act of August 5, 1909. So much of the second paragraph thereof as introduced by Senator Aldrich pertinent to this inquiry is as follows:

"Second. Such net income shall be ascertained by deducting from the gross amount of the income of such corporation, joint-stock company or association, or insurance company from all sources (first) all the ordinary and necessary expenses actually paid within the year out of income in the maintenance and operation of its business and properties; (second) all losses actually sustained within the year and not compensated by insurance or otherwise, including a reasonable allowance for depreciation of property, if any, and in the case of insurance companies the sums required by law to be carried to premium reserve fund; (third) interest actually paid within the year on its bonded or other indebtedness to an amount of such bonded and other indebtedness not exceeding the paid-up capital stock of such corporation, joint stock company or association, or insurance company, outstanding at the close of the year; (fourth) all sums paid by it within the year for taxes imposed under the authority of the United States or of any State or Territory thereof; (fifth) all amounts received by it within the year as dividends upon stock of other corporations, joint-stock companies or associations, or insurance companies subject to the tax hereby imposed.'

SECTION 38.

We will come to see that subparagraph second of said paragraph second was somewhat changed in the engrossed act as atually signed by President Taft, August 5, 1909, as follows:

[Language Aldrich amendment.]

Second. All losses actually sustained within the year and not compensated by insurance or otherwise, including a reasonable allowance for depreciation of property, if any, and in the case of insurance companies the sums required by law to be carried to premium reserve fund.

[Language of act as signed by President Taft.]

Second. All losses actually sustained within the year and not compensated by insurance or otherwise, including a reasonable allowance for depreciation of property, if any, and in the case of insurance companies the sums other than dividends, paid within the year on policy and annuity contracts and the net addition, if any, required by law to be made within the year to reserve funds.

It will be noticed that the items to be deducted were enlarged in the act as engrossed and signed by President Taft August 5, 1909, over the deductions enumerated in the Aldrich amendment to the tariff bill as offered by him June 29, 1909. It will also be noticed that the act as engrossed and signed by President Taft refers broadly to reserve funds" while the Aldrich amendment is limited to "premium reserve fund."

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It is quite apparent that Congress never contemplated the imposition of a tax measured by unabsorbed premiums of mutual fire insurance companies returned to policyholders from the classification of insurance companies given by Senator Cummins (vol. 44, Cong. Record, 61st Cong., 1st sess., p. 3981):

"There are three general kinds of insurance companies: First, the old-line companies, which do business under what is known as the 'legal-reserve plan'; that is, they collect enough from their policyholders to lay aside a legal reserve, which, if the policy be continued according to its terms, will pay out when the event happens against which the insurance is written. These old-line companies are of two sorts; one sort has capital stock and one sort has not. Then, we have another kind of insurance companies, known as 'assessment insurance companies,' that collect from time to time for the losses or for the payment of policies as they mature. Then, of course, there is another kind that insures against a particular event, such as accidents or the like."

Senator Cummins, therefore, had in mind only "assessment insurance companies" and did not take into consideration the method of a fire insurance company where a premium deposit is made, irrespective of the term of the policy, said premium deposit being the same for a one-year policy, a two-year policy, a three-year policy, a four-year policy, or a five-year policy from which premium deposit losses and expenses are deducted as they occur, month by month, and the balance left unabsorbed on the termination of the policy returned to the policyholder.

In the case of factory mutuals (such as those on whose behalf this brief is presented) the premium is simply a deposit proportionate to the sum insured and this deposit is the same in amount whether the policy is written for one year, two years, three years, four years, five years, or any other term, and under the by-laws of such companies there exists a contract obligation to return at the termination of a policy all the premium deposit which has not become absorbed by losses and expenses.

Confusion has come from confounding different kinds of insurance. The principles and methods of life insurance differ fundamentally from those of fire insurance. In fire insurance, the methods of stock companies differ widely from those of the mutual companies. The methods of dwelling-house mutuals differ materially as to premiums or premium deposits from those of the factory mutuals (such as those on whose behalf this brief is presented).

That in life insurance as well as fire insurance there are dividends properly so called, meaning profits and dividends improperly so called, meaning sums returned to policyholders, is apparent from the letter of Mr. Frederick Frelinghuysen, president of the Mutual Benefit Life Insurance Co. of Newark, N. J., found in the Congressional Record (vol. 44, Cong. Record, 61st Cong., 1st sess, July 2, 1909, pp. 4020-4021), as follows: "When such mutual life insurance companies are said to pay dividends you, of course, are aware that the so-called 'dividends' are merely a return to the policyholder of such premium charged or collected as has been found to be superfluous to have been saved by the economy of the management of the company. To impose this tax means that the provision these modest people are making for their families when the

SECTION 38.

insured is no longer able to provide for them, is to be assessed annually 2 per cent, for such return premium or dividends are arrived at in very much the same way as the balance of income is reached by this proposed law on which the tax is so laid.”

It will be noticed that the Aldrich amendment as offered by him June 29, 1909, allowed no deduction for moneys returned to policyholders. The act as engrossed and signed by President Taft August 5, 1909, broadly allows a deduction for all sums returned to policyholders, which, of course, would include unabsorbed premiums. These unabsorbed premium deposits so returned are (often) improperly called “dividends." There follows in the wording of the act an exception as to "dividends" and it must be assumed that Congress used this word in its proper sense as meaning "profits." In other words, it was intended to measure the tax on net income; "dividends" in the way of profits, when used in its proper sense, is only net income.

III. ATTITUDE OF THE COMMISSIONER OF INTERNAL REVENUE.

On December 16, 1911, Hon. Royal E. Cabell, Commissioner of Internal Revenue, handed down Treasury Decision 1743 (vol. 14, Treasury Dec., Internal Revenue, p. 134). In this opinion the Commissioner of Internal Revenue stated the following to be the contention of the insurance companies:

"First. That dividends declared by mutual and participating companies are not dividends in the commercial sense of the word, but are simply refunds to the policyholder of a portion of the overcharge collected from such policyholder at the time the annual premium of the policy contract is collected, which overcharge is merely held in trust by the company issuing the policy and annually or at stated periods all or a portion thereof is returned to the person holding the policy."

Having thus put the contention, Mr. Cabell answered it in the negative and denied the contention of the insurance companies and declared that the tax could be measured on the unabsorbed premium.

An examination of this opinion shows that the Commissioner of Internal Revenue had in mind life insurance companies and not the unabsorbed premiums of mutual fire insurance companies, such as those returned by factory mutual insurance companies on the termination of policies.

A further examination of the opinion discloses that the conditions discussed by the Commissioner of Internal Revenue have no counterpart in the case of factory mutual fire insurance companies, which do not advertise and which make no false or misleading statements as to the character of the unabsorbed premiums returned to policyholders. The Commissioner of Internal Revenue had in mind sums returned "annually" or at "stated periods," while in the case of factory mutual fire insurance companies the unabsorbed premiums are returned whether the policy runs one day, one month, three months, nine months, twelve months, a year and one month, two years and three months, four years and seven months, or any other time.

On the day previous, to wit, December 15, 1911, he handed down Treasury Decision 1742, paragraph 79 whereof (Vol. 14, Treasury Decisions, Internal Revenue, p. 130) is as follows:

79. Dividends declared by insurance companies are not deductible from gross income under the guise of rebates or otherwise, and such dividends when applied to the payment of renewal premiums, or to shorten the endowment or premium-paying period, or applied to purchase paid-up additions and annuities, must be considered and accounted for as income.

What has been said as to Treasury Decision 1743 is applicable to Treasury Decision 1742, above quoted.

IV. THE COURT DECISIONS.

On March 13, 1911, the Supreme Court of the United States handed down its opinion in Flint v. Stone Tracy Co. (220 U. S., 107), sustaining the constitutionality of the corporation excise tax. The opinion of Mr. Justice Day is a scholarly analysis of the act and expounds the general intent to measure the tax by a percentage of the net income calculated in the manner set forth in the act.

That unabsorbed premiums returned by mutual insurance companies to its policy holders are not to be used in measuring the tax and are to be deducted from gross income, was held by District Judge Cross, United States District Judge for the District of New Jersey, July 29, 1912, in Mutual Benefit Life Insurance Co. v. Herold (198 Fed. Rep., 199). The second proposition of the syllabus is as follows;

"Corporation Tax Act (Act Cong. Aug. 5, 1909, c. 6, 36 Stat., 112, U. S. Comp. St. Supp., 1911, p. 946), section 38 imposes an excise tax on insurance companies equivalent

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