Indebtedness Incurred or Continued to Purchase or Carry Tax Exempt Securities. Prior to its amendment by the Revenue Act of 1917, it was held under the 1916 Law that interest paid on indebtedness could be deducted regardless of whether or not the indebtedness was incurred for the purchase of bonds, the interest upon which was exempt from taxation. This ruling in effect permitted a double deduction, that is, the interest paid on the money so borrowed could be deducted and the income derived from the money so borrowed and invested could also be deducted. The 1917 Law did not permit the deduction of interest paid on "indebtedness incurred for the purchase of obligations or securities the interest upon which is exempt from taxation as income under this title." The Revenue Act of 1918 does not permit the deduction of interest paid or accrued 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 interest upon which is wholly exempt from taxation under this title as income to the taxpayer." 5 State and municipal bonds are obligations or securities falling within this class, as well as National honds issued prior to September 1, 1917. Interest on indebtedness incurred for the purchase of Liberty bonds of the second issue (the interest on which is not entirely exempt from the surtax) was held deductible regardless of the limitation contained in the 1917 Law. By the parenthetical clause of the 1918 provision taking obligations of the United States issued after September 24, 1917, out of the exception to the deductibility of interest, the Revenue Act of 1918 makes it clear that interest on indebtedness incurred or continued to purchase or carry Liberty bonds of the second, third or fourth loan will be allowed as a deduction. The extension of the exception to the de

4 Revenue Act of 1916, §§ 5 (a), 12 (a), as amended by the Revenue Act of 1917.

5 Revenue Act of 1918, §§ 214 (a) 2, 234 (a) 2.

6 T. D. 2541.

ductibility of interest to indebtedness "continued" as well as incurred, and incurred or continued to "carry" as well as to purchase tax-exempt securities should be noted.

Interest Paid Within the Year. The 1909 Law provided for the deduction of "interest actually paid within the year" and it was contended by the Treasury Department that this provision required that the interest should be both accrued and paid within the same year. It was held, however, that interest actually paid within the year although previously accruing should be permitted as a deduction.7 The 1913 Law provided for the deduction of interest paid within the year by individuals, and "interest accrued and paid within the year" by corporations. In a ruling appearing under that law it was held that in the case of corporations the deduction should be limited to interest which had both accrued and been paid within the same year. The 1916 Law permitted the deduction of interest "paid within the year."9 The Revenue Act of 1918 permits the deduction of interest "paid or accrued within the taxable year. "" 10 It does not seem essential under these provisions that interest should have accrued or become payable in the year in which it is paid in the case of taxpayers reporting on a basis of cash receipts and disbursements.

Interest Faid or Accrued Within the Year. It will be noted that the Revenue Act of 1918 permits the deduction of interest "paid or accrued" within the taxable year.11 The term "paid or accrued" is to be construed according to the method of accounting upon the basis of which the

7 Anderson v. 42 Broadway Co., 213 Fed. 777. The Supreme Court in reversing the lower court (239 U. S. 69) did not pass on the question of deducting interest accrued in one year and paid in another.

8 T. D. 1960.

9 Revenue Act of 1916, §§ 5 (a), 12 (a), as amended by the Revenue Act of 1917.

10 Revenue Act of 1918, §§ 214 (a) 2, 234 (a) 2. 11 Revenue Act of 1918, §§ 214 (a) 2, 234 (a) 2.

net income of the taxpayer is computed.12 Under the 1916 Law corporations keeping books of account on an accrual basis were permitted to deduct interest for the year whether paid or not, when such interest was shown as a charge against accrued income upon the books of account.13 Interest Paid by Corporations. The limitations imposed by the 1916 Law upon the amount of interest which might be deducted by domestic and foreign corporations are referred to elsewhere in this book.14

12 Revenue Act of 1918, § 200.

13 T. D. 2625.

14 See Chapters 12 and 14 on Corporations and Foreign Corporations respectively.

CHAPTER 29

DEDUCTION OF TAXES

In the case of citizens and residents and domestic corporations the provisions of the Revenue Act of 1918 for the deduction of taxes are the same. Such taxpayers may deduct taxes paid or accrued within the taxable year imposed (a) by the authority of the United States, except income, war-profits, and excess-profits taxes; or (b) by the authority of any of its possessions, except the amount of income, war-profits and excess-profits taxes allowed as a credit against the tax of the taxpayer; or (c) by the authority of any State or Territory, not including those assessed against local benefits of a kind tending to increase the value of the property assessed; or (d) by the authority of any foreign country except the amount of income, warprofits and excess-profits taxes allowed as a credit against the tax of the taxpayer. Non-resident aliens and foreign corporations may deduct the taxes included in items (a), (b), and (c) above; in lieu of the taxes included in item (d) above they are allowed to deduct taxes imposed by the authority of any foreign country (except income, warprofits and excess-profits taxes, and taxes assessed against local benefits of a kind tending to increase the value of the property assessed).1 The deduction of taxes by non-resi

1 Revenue Act of 1918, §§ 214 (a) 3, 234 (a) 3. In the case of non-resident aliens and foreign corporations the taxes which might be deducted were limited to those assessed by the United States or its territories or possessions or under the authority of any state, county, school district or municipality or other taxing subdivision of any state, paid within the United States, within the year, except such taxes as were not deductible by any class of taxpayers. (Revenue

dent aliens is only allowed if they file a true and accurate return of income from all sources, corporate or otherwise, in the United States in the manner prescribed by law.2 In addition to the taxes which are allowed as a deduction against gross income in computing net income, certain taxes are permitted by the Revenue Act of 1918 to be credited against the tax otherwise payable. These credits are also discussed in a chapter following.3

Taxes Paid or Accrued Within the Year. Under the 1913 Law and the 1916 Law the provisions for deducting taxes expressly limited deductions to taxes paid within the year. It was held by the Treasury Department that reserves for taxes could not be established as only such sums as were actually paid within the year could be deducted, that is, the aggregate of the amounts actually paid as shown by the cash book. The Revenue Act of 1918 provides for the deduction of taxes "paid or accrued." The term "paid or accrued" is to be construed according to the method of accounting upon the basis of which the net income of the taxpayer is computed.5

Taxes Not Deductible. The Revenue Act of 1918 expressly provides that no taxpayer shall deduct (a) income, war-profits and excess-profits taxes imposed by the authority of the United States, (b) taxes assessed against local benefits of a kind tending to increase the value of the

Act of 1916, §§ 6 (a), 12 (b).) For the special rulings applicable to non-resident aliens and foreign corporations see Chapters 5 and 14 on Non-Resident Aliens and Foreign Corporations, respectively. 2 Revenue Act of 1918, § 217.

The

5 Revenue Act of 1918, § 200. See Chapter 34 on Returns. provision of the 1916 Law allowing individuals and corporations to report on a basis other than that of actual receipts and disbursements, and the rulings by the Treasury Department thereunder, seemed to permit, in the case of individuals or corporations reporting on an accrual basis, the deduction of the amount of taxes accrued on their books or the amounts reserved for the payment of taxes providing such amounts did not exceed the actual liability incurred during the year. (T. D. 2433.)