the year out of earnings in the maintenance and operation of DUSSINESS BUIL With respect to deductions the treasur letin of December 3, 1909 (T. R. No. 32. as follows: "The specified deductions actually paie wit to me statute and as described in article 3 preceding of expenses and charged under the respective su returned for ordinary and necessary expensi out of income in maintenance and operative e s of the corporation should not, however, emuras of fixed property which are otherwise to be taken heading in the authorized deductions, nor expe charged to such allowances for depreciation mele previous years. In ascertaining expenses ductions to be made under this article. supplies on hand for use should include materials and supplies only to the amount bursed and used in operation and mainte return is made. It is immaterial whether the deductions ments in cash, or whether evidenced be R. acknowledged by the corporate officers and so entered on the books as to constitute a liability against the assets of the corporation, joint stock company, association or insurance company making the return. The act further provides that there shall be deducted from the amount of the net income of each of the companies named in the act as being subject to the payment of the federal corporation tax, ascertained as prescribed above, the sum of $5,000. The net income, therefore, is the remainder of the gross income after making the foregoing specified deductions. (T. R. December 31, 1909, No. 31, see Appendix C.) Sec. 75. Deduction of Expense of Maintenance of Business and Properties. The act provides that the net income of any specific company shall be ascertained by deducting from the gross amount of the income of such company received within the year from all sources all the ordinary and necessary expenses actually paid within the year (from January 1 to December 31) out of income in the maintenance of its business and properties. The word "maintenance" as here used, does not include (according to the views of the treasury department, see Appendix I, sections 52, 53) moneys taken from the gross income of the company in the way of betterments of a plant, installation of new fixtures and machinery. Under the foregoing ruling any expenditures made from the gross income, which tend to keep up a particular plant to its normal requirements, as well as to enable it to meet the increasing and legitimate demands of a growing business, would not represent proper deductions as expenses. This, for the reason that betterments are required as additions to the capital assets of the company, while moneys expended in repairs are regarded as being offset by allowances for depreciation. The treasury department has held, however, that the cost of erecting a building included in a lease under which the property is held by the company is a proper deduction to be prorated according to the time fixed by law. (T. R. March 29, No. 1606, see Appendix K.). But funds set aside by the company in insuring their own property are not regarded as a proper deduction. (T. R. March 29, 1910, No. 1606, see Appendix K.) Sec. 76. Deduction for Expense of Operation of Business and Properties. - Under the terms of the act, all ordinary and necessary expenses connected with the operation of business and property are a proper deduction. Thus, the treasury department holds that commissions allotted salesmen, even when paid in stock, inay be deducted as expense of operation if so charged upon their books. (T. R. March 29, 1910, No. 1606, see Appendix K.) Sec. 77. Meaning of Ordinary Expenses. - Only those expenses actually paid are proper subjects for taxation (act, paragraph 2, line 5). In addition to requiring that the expenses shall have been actually paid, the act provides that such expenses must be part of the ordinary and necessary expenses. To permit of this being a basis for reduction an expense must be shown to be of this character. Betterments and repairs are not proper deductions as expenses, the former being additions to the capital assets of the company, and the latter being offset by allowance for depreciation. (T. R. March 29, 1910, No. 1606, see Appendix K.) Cost of replacing old rails, structures, etc., not to be regarded as ordinary and necessary expenses. Depreciation during the year will be allowed, however, in such cases. (T. R. March 29, 1910, No. 1606, see Appendix K.) Dividends paid employees in lieu of wages not proper deduction as expenses. (T. R. March 29, 1910, No. 1606, see Appendix K.) Sec. 78. Meaning of Necessary Expenses. An expense may be a necessary expense and a proper subject for deduction, but under the statute, not one of the ordinary expenses of the company. Pensions paid or gifts made to employees are gratuities, and not "ordinary and necessary expenses." (T. R. March 29, 1910, No. 1606, see Appendix K.) Where allowances on account of salaries are deemed excessive, and for the purpose of evading the tax due, investigation will be made, and if the facts warrant, prosecution will follow. (T. R. March 29, 1910, No. 1606, see Appendix K.) Sec. 79. Meaning of Expenses Actually Paid Out of Income. - In order to be a proper subject for deduction, the expense must be paid out of income. In other words, the expense must be paid from revenue and not out of capital stock account. The treasury department, while holding that sales of stock and bonds are to be regarded as sales of capital assets has, nevertheless, held that proceeds derived from the sales of bonds used in deferring ordinary and necessary expenses are a proper deduction in determining the company's net income. (T. R. March 29, 1910, No. 1606, see Appendix K.) Sec. 80. What Are Proper Charges for Rentals or Franchise Payments? The act permits the inclusion as operating expenses of all charges, such as rentals or franchise payments, required to be made as a condition to the continued use or possession of the property. Such charges as are here enumerated would seem to be both ordinary and necessary, and, therefore, the addition of this phrase would seem to have been made largely by way of definition rather than with any intention of enlarging the subject-matter of deductions themselves. The Attorney-General has rendered an opinion (February 21, 1910) to the effect that mortgage indebtedness on real estate, if assumed by the corporation acquiring such real estate may be included in the indebtedness of the corporation, but if it is not assumed, and remains only as a lien on the property, interest paid thereon may be deducted as a charge made as a condition to the continued use or possession of the property. Sec. 81. Deduction for Losses. - 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 with insurance companies the sums other than dividends paid within the year on policy and annuity contracts, and the net additions, if any, required by law to be made within the year to reserve funds are proper deductions. (Act, section 2, lines 4149.) Sec. 82. Meaning of Losses. Losses as used in the Federal Corporation Tax Act may be defined to embrace any transaction or things whereby the assets of the company have become thereby impaired. In the language of the treasury department, "the deduction for losses must be in respect of losses actually sustained during the year and not compensated by insurance or otherwise. It must be based upon the difference between the cost value and salvage value of the property or assets, including in the latter value such amount, if any, as has in the current or previous years been set aside and deducted from gross income by way of depreciation as defined in the following section and not been paid out in making good such depreciation." It is immaterial whether the deductions are evidenced by actual disbursements in cash or whether evidenced in such other way as to be properly acknowledged by the corporate officers and so entered on the books as to constitute a liability against the assets of the corporation, etc., making the return. Sec. 83. Meaning of Phrase "Losses Actually Sustained Within the Year." The words "actually sustained" as herein used would seem to refer to liquidated liabilities and exclude contingent or possibe liabilities. In addition to the fact that the loss must be actually sustained, the act provides that it must have been sustained within the tax year which runs from January 1 to December 31. Sec. 84. Condition That Losses Must Not Have Been Compensated By Insurance or Otherwise. The purpose of inserting this particular exception from the general enumeration of deductions, is by way of recognition that a loss not only covered by insurance, but fully compensated by insurance, cannot properly be charged as a loss within the meaning of the act. It is somewhat difficult to know just what is meant by the word "otherwise " as used in the act (Act, paragraph 2, lines 9-11). The act reads This might in clude, for example, a loss caused by embezzlement of a clerk, or by fire caused by explosion from an engine. In both of these cases |