In rejecting the claim for refund, the Unit states in part:

Inasmuch as the additional salary paid to B was not actually paid to him during 1917 and was not an accrued liability of your company for 1917, this office can not accept amended return for 1917 from you in which your taxable net income is reduced by a corresponding deduction of the additional compensation paid for services rendered in 1917.

The Committee has carefully considered the foregoing statement of facts and the arguments in support of the taxpayer's contention, and while it is true that the additional compensation of 2 dollars was in reality payment for services actually performed in 1917, and that the total of 3x dollars does not appear to be in excess of a reasonable allowance, it is equally true that such additional compensation was not paid pursuant to a binding contract or a resolution adopted before the close of the taxable year, and consequently did not constitute an "ordinary and necessary expense paid or incurred during the taxable year" within the purview of section 234 (a)1, Revenue Act of 1918. It is to be understood that the treatment of questions affecting reasonable allowance for salary deductions which may be claimed in 1917 returns pursuant to section 12 (a), Revenue Act of 1916, as amended by the Revenue Act of 1917, should be in all respects similar to the treatment of like questions arising under the Revenue Act of 1918.

In the consideration of the question arising in the instant case the Committee has referred to T. B. M. 86 (C. B. 1, p. 106), which holds that:

Salaries voted subsequent to the close of any taxable year, and also subsequent to the close of the books for such taxable year, can not be considered an ordinary and necessary expense of doing business.

In discussing the question arising in the cases under consideration at the time T. B. M. 86 was written, the Advisory Tax Board quoted a portion of section 234 (a)1, Revenue Act of 1918, which provides that:

All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered.

and followed by stating that:

The word including" indicates clearly that the latter part of the sentence under consideration can not be separated from the first part in the manner argued by the attorney. "Include" means to enclose within; to embrace as a component part. Such being the case, these payments do not fulfill the requirements of the law so as to make them proper deductions. While ordinary and necessary expenses, they were neither paid nor incurred during the taxable year.

In the instant case it is evident, as before stated, that the additional compensation of 24 dollars was not paid or accrued in 1917; nor did there exist any legal liability for the payment of such additional compensation in that year; therefore, it is recommended in the appeal of the M Company that the action of the Income Tax Unit in rejecting claim for refund, disallowing additional compensation claimed as a deduction for 1917 where such additional compensation was not as a matter of fact authorized or paid until 1919 be sustained; further, that such additional compensation be allowed as a deduction under the heading of ordinary and necessary expenses in the taxpayer's return for the year 1919, in which year the payment was actually made.

SECTION 214(a)1, ARTICLE 105: Compensation

for personal services.

(Also Section 218, Article 321.)

24-21-1686 O. D. 947

By the terms of a partnership agreement one of the members of the partnership is required to pay out of his own funds the compensation of one of the employees of the partnership who performs a part of the duties delegated to said member.

Held, that the amount so paid constitutes a proper deduction in the income tax return of the member under section 214(a)1 of the Revenue Act of 1918.

SECTION 214 (a) 1, ARTICLE 107: Bonuses to

employees.

11-21-1509 A. R. M. 114

The Committee is in receipt of a request for advice as to the proper method of treating for income-tax purposes the difference between the original cost of a company's stock and the market value thereof at the time of distribution where such stock was bought in the open market by the company for the purpose of distribution as additional compensation to its employees.

In the judgment of the Committee, Office Decision 570 (C. B. 3, p. 144), correctly holds that the compensation to the employee is the market value of the stock at the time he receives it, and that consequently the market value at the time of distribution is the amount which the corporation is entitled to deduct as an ordinary and necessary expense of business, assuming, of course, that the compensation is reasonable and proper.

Article 542, Regulations 45, provides that "a corporation realizes no gain or loss from the purchase of its own stock," and article 563 provides that "a corporation sustains no deductible loss from the sale of its capital stock." Article 861 deals with cases where stock has been originally issued or exchanged by a corporation for property and is returned to the corporation as a gift, or for a consideration substantially less than its par value. The proceeds derived from the subsequent sale of such stock is included in computing invested capital.

Article 862 deals with the case where a corporation has purchased during the taxable year some of its stock either for retirement or to hold in its treasury, and provides that "the full amount derived in cash or its equivalent from the resale of the stock may be included in the invested capital from the date of such resale unless the stock had been purchased out of the earnings of the taxable year."

It appears that the corporation is paying compensation in its own stock. The difference between the cost of such stock and the amount of the compensation paid, which is the market value of the stock at the time of payment, may not under the regulations referred to above enter into the computation of gain or loss of the corporation. Therefore, if at the time of distribution the market value of the stock is less than its cost, the company is not entitled to deduct the difference as a loss in computing its net income. If the market value is greater at the time of distribution, the corporation is not required to report as income the difference between the cost and market value. In view of the foregoing it is the opinion of the Committee that a corporation realizes no gain or loss from the purchase of its own.

stock, and that it sustains no loss from the subsequent resale of its own capital stock.

SECTION 214(a) 1, ARTICLE 109: Rentals. (Also Section 214(a) 10, Article 203.)

4-21-1406 Sol. Op. 86

CORPORATION INCOME TAX-SECTION 12(a) FIRST AND SECOND, REVENUE ACT OF 1916, AND SECTION 234(a) 1 AND 9, REVENUE ACT OF 1918.

Under an option to purchase or so-called "bond and lease" agreement, providing for the payment of royalties on ore mined and for the payment at stated times of the amounts necessary to bring the total amounts paid to certain specified sums, and giving an option to the purchaser to take title to the property upon the payment of a specified amount upon which the royalties and deficiency payments are credited as part of the purchase price, the amounts paid as royalties constitute operating expenses and are deductible as such in determining net income.

The additional sums paid to make up the amounts of the several installments when due are capital investments in the nature of bonuses recoverable through deductions for depletion, computed upon the total sum of such additional payments to the end of the tax year.

Where, as in this case, the option is forfeited, the capital sum remaining to be recovered is deductible as depletion in the return for the year in which the forfeiture occurs.

The question is presented whether payments made by the M Company, under an option to purchase are deductible as operating expenses or are to be capitalized and recovered through deductions for depletion over the life of the property.

Section 12(a) of the Revenue Act of 1916 provides in part:

In the case of a corporation, such net income shall be ascertained by deducting from the gross amount of its income received within the year from all sources

First. All the ordinary and necessary expenses paid within the year in the maintenance and operation of its business and properties, including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity. Second. depletion thereof

*

*; (b) In the case of mines a reasonable allowance for

**

Section 234(a) 1 and 9 of the Revenue Act of 1918 contain substantially similar provisions.

In 1915 an agreement was entered into between the N Company and A, the material provisions of which are as follows:

THIS AGREEMENT,

WITNESSETH: That

*

* *

* the said party of the first part, does hereby give, grant and extend unto the said party of the second part the right, privilege and option to purchase, for the sum of 48 dollars, payable at the time and in the manner hereinafter specified, all those certain United States patented lode mining claims known as the

*

*

That the said purchase price of 48 dollars is payable as follows, to wit: 1x dollars in seven (7) months from the date hereof; 61r dollars in twelve (12) months from the date hereof; 12 dollars in eighteen (18) months from the date hereof; 12x dollars in twenty-four (24) months from the date hereof; and 16 dollars in thirty (30) months from the date hereof.

IT IS FURTHER AGREED that the party of the second part may take possession of the mining claims aforesaid immediately upon the execution of this instrument, and shall remain in complete and exclusive possession of the same during and throughout the life of this agreement,

IT IS FURTHER AGREED that the party of the second part shall have the right to work and develop said mining claims and to extract, ship and sell ores therefrom, paying thereon a royalty on ores running four per cent (4%) or under of ten per cent (10%), and on ores running over four per cent, fifteen per cent (15%), of the net smelter returns on ores so shipped and sold;

*

And second party further agrees that the above stated royalties shall be paid in installments from time to time, * *, the same to be by first party applied

on account upon the purchase price installment next maturing after the date of such smelter return payments, and any deficit in the total amount of such purchase payment at the end of any period not paid by the smelter returns, shall be paid in cash.

IT IS FURTHER AGREED AND UNDERSTOOD that, if second party shall * * * terminate this instrument * * he shall pay first party, notwithstanding, royalties upon all ores mined and overground

** *

*

IT IS EXPRESSLY AGREED that, in the event the said party of the second part shall fail to make any of the payments of the purchase price aforesaid, or fail to perform any of the conditions hereof, this agreement shall immediately become null and void, and of no further force and effect, at the option of the first party. * * *, and any and all payments of the purchase price, and all payments of royalties already paid or payable out of ores mined but not smelted shall be paid, held, and deemed forfeited unto the said party of the first part, to be kept and retained by it absolutely as liquidated damages, and as payment in full to continue the option hereby created in effect up to the time of the second party's breach. **

IT IS FURTHER AGREED that the said party of the second part may at any time terminate this agreement by giving notice of such intention to the party of the first part, * * *. But it is expressly understood that the giving of such notice of his intention to terminate this agreement on the part of the party of the second part, shall in nowise relieve him from further liability to forfeit all payments of purchase price and all payments of royalties theretofore made by him in pursuance of this agreement.

IT IS FURTHER UNDERSTOOD AND AGREED, and first party covenants, that, when the second party shall have paid to it the entire sums of money herein recited as the purchase price of the foregoing property, it will execute and deliver to the second party a good and sufficient deed of all the mining claims aforesaid,

IT IS MUTUALLY AGREED that if this contract be terminated by reason of the election of second party to terminate the same, as provided herein, he may, or because of his breaches of the terms and conditions hereof, it shall not be held to have created any lien, estate, or equity in or to the said mining claims, or any part hereof, in favor of second party.

Shortly after the execution of the above agreeement the M Company, the taxpayer herein, was organized, and its entire capital stock in the amount of 34x dollars was issued to A in consideration of the assignment of the above contract. The mining company entered upon the property, and began operations in accordance with the terms of the contract. In July, when, under the contract, the first installment of 14 dollars fell due, it appears that the sum of a dollars had been paid to the owner as royalties on the ore mined, and the sum of dollars was paid by the corporation in cash as the balance due. În November the sum of 4 dollars was paid by the corporation as the balance due upon the second installment." Similiar payments were made from time to time until there had been paid in all, as royalties and additional payments, the sum of 39 dollars. On January 20, 191-, all of the ore appears to have been removed from the mine, and the corporation made no further payments, forfeiting its right under the contract. The contention is now made on behalf of the corporation that all of the payments so made consti

tuted ordinary and necessary business expenses, and were deductible as such from the gross income of the several years in which they were made.

As stated by Mr. Lindlay in his excellent work on mines (3 Lindlay on Mines, sec. 859 (a) and sec 861):

It is often difficult in a given instance to find a technically correct legal name for the contract employed, for it may possess some of the characteristics of two or more well-defined classes. What is more important, however, from a practical standpoint is to ascertain from the contract what are the respective rights of the contracting parties.

Under the contract above set out it is clear that the M Company could acquire title to the property only upon completion of the stipulated payments, and that the payments made by it as royalties on account of ore actually removed differed in no respect from the payments made by any lessee under the recognized terms of mining leases. It seems equally clear that not only did the additional payments made to complete the sums stipulated to be paid under the contract constitute amounts paid for the privilege of continuing the operation, but that they also represented an investment in the ore remaining in the mine at the date of payment, and this fact is not negatived by the further fact that such right was subject to forfeiture by the mining company upon failure to make the payments in accordance with the contract. So long as these payments were duly made they gave rise to an equity in the company which would have sustained a suit for specific performance by the owner. These additional payments, therefore, constituted investments in the property which were chargeable to capital account and recoverable pro rata with any amounts expended for development and plant over the estimated life of the ore body.

If the mining company had completed the payments in accordance with the contract the total amount of the payments in excess of the royalties paid for the mineral extracted, and not theretofore recovered as depletion, would have constituted an investment in the remaining mineral in the mine at the date title to the property vested in the company and would have been recoverable through deductions for depletion over the remaining life of the operation. Upon the forfeiture of the lease in January, 191-, any capital sum not already recovered through depletion deductions was deductible under the head of depletion in the return for that year.

It is, therefore, held that the amounts paid by the M Company as royalties constituted operating expenses and were deductible as such in the returns of the respective years in which they were paid; that the additional sums paid from time to time in accordance with the terms of the option constituted capital investments to be recovered through deductions for depletion, computed upon the total sum of such additional payments to the end of the tax year, spread over the estimated remaining operating life of the mine; and that any amount remaining to be so recovered upon the forfeiture of the lease was deductible as depletion in the year in which the forfeiture occurred. CARL A. MAPES,

Solicitor of Internal Revenue.