Section 213 (e). Replacement fund.

During the war, in the case of property requisitioned for war purposes by the Government and property lost or destroyed in whole or in part through war hazards, especially in the case of ships, it happened that at the time of requisition or loss the market value of such ships was considerably increased over the cost or market value as of March 1, 1913, in cases in which the property was acquired prior to that date, and that in practically no case would the taxpayer have been willing to sell the property for its appraised value at the time of requisition or loss.

To require the taxpayer to pay income and war profits and excess profits taxes upon the difference between the cost or market price on March 1, 1913, and the compensation received at the time of requisition or loss would have been to take such a large proportion of the amount received for the vessel that, although the owner desired to replace the same, the taking of the tax by the Government would have made it impossible in practically every instance.

In all cases where the owner desired to replace the vessel the department allowed him to create a replacement fund and upon giving bond and security for the payment of the taxes assessable by the Government to defer payment of the taxes for a reasonable period in order to replace the vessel, and it required a taxpayer to carry the new or restored property in its accounts at an amount not in excess of that at which the requisitioned, damaged, or destroyed property was carried, except and to the extent that such new or restored property had an increased productive capacity.

Treasury Decision 2706 sets forth the replacement fund procedure adopted by the Treasury Department.

It has been suggested that this procedure should be made applicable to all cases of requisitioned property by the Government, or property lost or destroyed, in whole or in part, by fires, storms, shipwreck, or other casualties.

It has been suggested that this could be accomplished by an amendment in substantially the following form:

Amend section 213 by adding at the end thereof a new subdivision as follows:

(e) In the case of property title to which has been requisitioned by the Government, or property which has been lost or destroyed, in whole or in part, by fire, storm, shipwreck, or other casualty, the amount received by the owner as compensation for the property in excess of the value of the property on March 1, 1913, or its cost, if acquired after that date, may be placed in a replacement fund for the replacement in kind of the lost or damaged property. In case a taxpayer establishes a replacement fund, the entire amount of the

compensation so received may be held in such fund, and the accounting for gain or loss thereupon deferred for a reasonable period of time, to be determined by the Commissioner, with the approval of the Secretary.

In such cases the taxpayer shall make application under oath to the Commissioner for permission to establish such a replacement fund. The application shall state all the facts relating to the transaction and that the taxpayer will proceed immediately to replace or restore such property.

The taxpayer shall be required to furnish a bond with such security or surety as the commissioner, with the approval of the Secretary, shall require for an amount not less than the estimated income, war-profits, and excess-profits taxes assessable by the United States upon the income so carried to the replacement fund. In lieu of such bond the taxpayer may at his option deposit as security for such estimated amount of taxes, obligations of the United States, such obligations to be held in trust as such security in a bank or trust company designated by the Commissioner, with the approval of the Secretary.

When the replacement or restoration is made, the new or restored property shall not be valued in the accounts of the taxpayer at an amount in excess of that at which the requisitioned, damaged, or destroyed property was carried, except and to the extent that such new or restored property has an increased productive capacity. Section 214 (a) (2) and section 234 (a) (2). Deductibility of interest paid on indebtedness incurred to purchase or carry obligations of the United States.

These paragraphs, as now worded, permit taxpayers (individuals and corporations, respectively) to borrow money for the purpose of purchasing or carrying tax-free 33 per cent Victory notes and to deduct interest paid upon such borrowed money, although the interest received from such notes is exempt from all Federal, State, and local taxation except estate or inheritance taxes.

It has been suggested that this departure from the principle that taxpayers, in computing taxable income, should not be permitted to deduct interest paid on indebtedness contracted to purchase or carry tax-free securities, is unwise and should not be continued and that the law should be amended so as to remove the exceptionally favorable status which has been accorded this particular issue of Government securities.

It has been suggested that this change could be accomplished by amendments in substantially the following form:

Strike out paragraph (2) of subdivision (a) of section 214 and insert in lieu thereof;

(2) All interest paid or accrued within the taxable year on its indebtedness, except on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917 the income from which is subject, to graduated additional income taxes, commonly known as surtaxes and excess-profits and war-profits taxes), the interest upon which is wholly exempt from taxation under this title as income to the taxpayer, or, in the case of a nonresident alien individual, the proportion of such interest which the amount of his gross income from sources within the United States bears to the amount of his gross income from all sources within and without the United States.

Strike out paragraph (2) of subdivision (a) of section 234 and insert in lieu thereof:

(2) All interest paid or accrued within the taxable year on its indebtedness, except on indebtedness incurred or continued to purchase or carry obligations or securities (other than obligations of the United States issued after September 24, 1917 the income from which is subject to graduated additional income taxes, commonly known as surtaxes and excess-profits and war-profits taxes), the interest upon which is wholly exempt from taxation under this title as income to the taxpayer, or, in the case of a foreign corporation, the proportion of such interest which the amount of its gross income from sources within the United States bears to the amount of its gross income from all sources within and without the United States;

Section 216. Personal credits of a taxpayer whose status changes during the year.

This section of the law does not specify whether the credits therein allowed are to be taken according to the status of the taxpayer at the beginning or at the end of the taxable year or on the basis of prorating the credits allowable under two or more statuses during the time within the taxable year throughout which each status continued. It has been suggested that these credits are not sufficient in amount to justify the inconvenience of prorating and that the ruling of the department that the status of the taxpayer at the close of the taxable year is controlling should be confirmed by legislation.

It has been suggested that this change could be accomplished by an amendment in substantially the following form:

Amend section 216 by adding a new subdivision at the end thereof as follows:

(f) The credits allowed by subdivisions (c), (d), and (e) of this section shall be determined by the status of the taxpayer on the last day of the period for which the return of income is made, but in

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the case of an individual who dies during the taxable year, such credits shall be determined by his status at the time of his death, and in such case full credits shall be allowed to the surviving spouse, if any, according to his or her status at the close of the period for which such survivor makes return of income.

Section 216 (a), section 234 (a) (6), and section 325 (a). Credit or deduction allowed for dividends received from foreign corporations the net income of which is in part subject to income tax.

Under the wording of these sections a taxpayer who receives a dividend from à corporation who receives no income from sources within the United States must pay full normal or corporation tax upon such dividend, but if any portion-however small-of the income of the foreign corporation is derived from sources within the United States the entire dividend is an allowable credit to the individual who receives the dividend.

It has been suggested that under this condition of the law a foreign corporation has only to make such arrangements as will result in securing a small amount of income from sources within the United States in order to exempt from income tax all dividends paid to American stockholders, and that the law should be amended so that this credit to the American stockholder shall be limited to that proportion of the dividend which the net income of the foreign corporation subject to income tax bears to its entire taxable income.

It is further urged in support of this suggestion that the taxability of the dividend has important reactions upon the invested capital of any American stockholder subject to profits tax because of the fact that stock of a foreign corporation is an admissible asset if the dividend be in any part subject to tax, whereas it is an inadmissible asset if the dividend is exempt.

It has been suggested that these changes could be accomplished by an amendment in substantially the following form:

(1) That subdivision (a) of section 216 be amended by striking the semicolon and substituting therefor a colon and the following:

Provided, That in the case of dividends received from a foreign corporation there shall be credited under this subdivision only that proportion of such dividends which the net income of such foreign corporation subject to income tax under this act for the year ending prior to the beginning of the taxable year in which such dividends were declared (or so much of such years as the corporation was in existence) bears to its entire taxable income for the same year as computed for purposes of income tax under this act;

(2) That paragraph (6) of subdivision (a) of section 234 be amended by striking out the semicolon and substituting therefor a colon and the following:

Provided, That in the case of dividends received from a foreign corporation there shall be deducted a proportion thereof computed in the manner prescribed in subdivision (a) of section 216;

(3) That the definition of "inadmissible assets" in section 325 be amended by striking out the semicolon at the end thereof and adding a colon and the following:

Provided, That in the case of capital invested in stock of a foreign corporation a part thereof shall be deemed inadmissible assets equal to the part of the dividends deductible under the provisions of paragraph 6 of subdivision (a) of section 234;

Section 226. Returns when accounting period changes.

Section 226 provides for returns of income for fractional parts of years in cases in which there is a change from fiscal year to calendar year, calendar year to fiscal year, or one fiscal year to another, and in cases of the first income tax returns of taxpayers. By section 239 the provisions of this section are made applicable to corporations. Section 226 provides for a corresponding reduction of credits in the case of individuals and section 239 in the case of corporations. Provisions for reduction of war and excess-profits credits are contained in sections 305 and 311. Section 326 contains a provision with respect to invested capital which effects a proper adjustment of the rates of profits taxes in cases of fractional parts of years. There is, however, no provision in the case of individuals, which adjusts the rates of surtaxes in cases of fractional parts of years.

It has been suggested that provision should also be made for the adjustment of the rates of surtaxes in the cases of individuals making return for fractional parts of years.

It is urged in support of this suggestion that an individual who makes a return for a fractional part of a year secures a lower rate of surtax than would be applied to him if he made return for an entire

year.

It has been suggested that this change could be accomplished by an amendment in substantially the following form:

Amend section 226 by adding at the end thereof a new paragraph as follows:

In the case of a return for a fractional part of a year the surtax shall be such part of a surtax computed upon an amount twelve times the average monthly income for the fractional part of the year included in the return as the number of months in such period is of twelve months.