The rule of apportionment referred to in the article is stated in article 16 as follows:

In cases wherein other business is carried on in connection with the manufacture and sale or disposition of munitions or parts thereof, and the running expenses of the person making the return cover those incurred in the operation of the entire business and can not be segregated from those incurred in connection with other business, the expenses deductible for the purpose of this tax are such a portion of the entire expenses as the gross income received or accrued from the manufacture and sale or disposition of war munitions or parts thereof, is a portion of the entire gross income received or accrued from such entire manufacturing busiuess.

An inspection of the statute shows that only taxes "paid" are deductible from gross income. This term is defined in all the authorities as meaning the discharge of a debt through the delivery of its value in money or goods. The courts have uniformly given the term this construction in taxing statutes unless it was clear that the legislative body enacting the statute intended it to have a different meaning. In section 200, Title II, of the Revenue Act of 1918, Congress provided that

The term "paid," for the purposes of the deductions and credits under this title, means "paid or accrued

This enlarged meaning of the word "paid" is confined to Title II of the Act, which is concerned with the imposition of the income and excess profits taxes.

It must, therefore, be held that in a munition manufacturer's tax return for either 1916 or 1917 only taxes actually paid are deductible. Regulations 39 do not define the meaning of the phrase "with respect to the business or property relating to the manufacture. (Sec. 302 (d), Revenue Act of 1916.) It is apparent, however, that it was the intention of the regulations that taxes which were paid within the taxable year upon the property used in the manufacture of the munitions could be deducted. It is, therefore, held in consonance with Regulations 39 that all real property and like taxes which became due and payable within the taxable year and were actually paid within that year are deductible from gross income within the limitations prescribed by the regulations. It is to be noted, however, that where a corporation owns two or more plants the total product of one being the manufacture of munitions, the taxes paid in respect of that plant are deductible without any such proration as is provided for by article 16 of Regulations 39.

(2) Income taxes paid in 1916 for the year 1915 are not paid "with respect to the business or property relating to the manufacture" of munitions the net profits from which are subject to the tax. It must, therefore, be held that they are not deductible from gross income.

(3) Interest to be deductible must have been actually paid within the taxable year 66 on debts or loans contracted to meet the needs of the business, and the proceeds of which have been actually used to meet such needs." Article 17 of Regulations 39 provides:

The amount deductible from the gross income received or accrued from the manufacture and sale or disposition of munitions or parts thereof, on account of interest, is the amount of interest actually paid within the year on debts or loans contracted to meet the needs of the business of manufacturing such articles, and the proceeds of which were actually used to meet such needs. This deduction must not include any interest paid on debts or loans the proceeds of which were used to meet the needs of any other business in which the

manufacturer may be engaged. This deduction can be taken only from the gross income of the year in which the interest was actually paid.

This regulation is a paraphrase of the law so far as it relates to the phrase "debts or loans contracted to meet the needs of the business." The important question for determination is whether debts or loans contracted years before to meet the needs of a manufacturing business are comprehended by the phrase.

This tax is a munition manufacturer's tax. It is imposed upon profits made in the manufacture of munitions. The gross income and the deductions are all related to the manufacture of munitions. It seems clear, therefore, that the debts or loans referred to in the phrase "contracted to meet the needs of the business" are loans contracted to meet the needs of a munitions business. Therefore, it must be held that the manufacturer liable to the munition manufacturer's tax may not deduct from gross income any amount whatever for interest unless the interest was actually paid upon a debt or loan which was contracted to meet the needs of the munitions business.

This conclusion is strengthened by a provision in section 301 of the Revenue Act of 1916, which is to the effect-

That no person shall pay such tax upon net profits received during the year nineteen hundred and sixteen derived from the sale and delivery of the articles enumerated in this section under contracts executed and fully performed by such person prior to January first, nineteen hundred and sixteen.

Article 10 of Regulations 39, referring to this proviso, rules

The income received or accrued from the latter source being exempt from the tax, any expenses incident to the manufacture of such articles and creation of such incomes will not be deductible from the gross income contemplated by this article.

CARL A. MAPES, Solicitor of Internal Revenue.

SECTION 214(a) 3, ARTICLE 131: Taxes. (Also Section 212, Article 23.)

10-21-1503 L. (. 1059

CORPORATION INCOME TAX-REVENUE ACT OF 1916, SECTION 12(a); SECTION 13(d).

METHOD OF COMPUTING AND ACCOUNTING FOR MUNITION MANUFACTURER'S TAX WHEN TAXPAYER'S ACCOUNTS ARE KEPT ON THE ACCRUAL BASIS.

Where a corporation in 1916 kept its accounts on the accrual basis, and either accrued munitions taxes or credited amounts to a reserve set up to meet such taxes, thus taking advantage of section 13(d) of the Revenue Act of 1916, it became bound by the provisions of that section and Treasury Decision 2433, and the amounts so accrued or credited must, in computing income subject to tax for 1916, be deducted from gross income for that year, and not for 1917, during which year such nrunitions taxes were paid.

Section 13 (d) of the Revenue Act of 1916 is a qualifying section, and when accounts of a corporation are kept on a basis other than that of receipts and disbursements it qualifies the manner of making deductions authorized in section 12(a) of the Act, and the word "paid" in the latter section is to be read “paid or accrued," depending on how the accounts of the corporation are kept.

The question is presented whether the M Company, a corporation, considering the basis upon which its accounts are kept, is required,

in computing its income tax for the calendar year 1916, to accrue munitions taxes assessed against the company under Title III of the Revenue Act of 1916, and deduct the amount thereof from gross income in its tax return for that year.

The company, in its tax return for 1916, made no deduction from gross income on account of munitions taxes assessed for that year, but claims the right to and did deduct the amount of such taxes in its tax return for 1917. This was in accordance with the consistent policy of the company, which has made it a practice since 1912 to deduct in its tax returns only the amount of taxes actually paid. during the year for which the returns were rendered.

The munition manufacturer's tax is an excise tax of twelve and one-half per centum upon the entire net profits actually received or accrued for the year 1916 from the sale or disposition of certain articles therein specified, manufactured in the United States.

In computing net income subject to tax under Part II of Title I of the Revenue Act of 1916, domestic corporations were allowed certain deductions from their gross income. Those deductions are enumerated in section 12(a) of the Act. The provisions relating to general items of expense and taxes read as follows:

SEC. 12(a). In the case of a corporation, joint-stock company or association, or insurance company, organized in the United States, 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.

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Fourth. Taxes paid within the year imposed by the authority of the United States, or of its Territories, or possessions, or any foreign country, or by the authority of any State, county, school district, or municipality, or other taxing subdivision of any State, not including those assessed against local benefits.

The proper treatment of the item munitions taxes for income tax purposes depends not only upon the construction to be placed on the word "paid" as used in this section, but also upon the effect of section 13 (d) of the Act concerning the methods of keeping accounts, and Treasury Decision 2433.

Under revenue acts prior to the Revenue Act of 1916, the only recognized basis for keeping accounts was that of actual receipts and disbursements. Giving official recognition to the fact that it is the common practice for all large business enterprises to keep their accounts on the accrual basis, this Department permitted the accrual of certain items of expense and the use of inventories. This practice was adopted to effectuate as nearly as possible, without doing violence to the language employed, the real purpose of those Acts, namely, to reflect the true income of the taxpayer upon which the tax was levied. However, taxes were not permitted to be accrued. They were deductible only in the year in which actually paid, and this remained the practice at least until the Revenue Act of 1916 became effective.

Section 13 (d) of the Revenue Act of 1916 is as follows:

A corporation, joint-stock company or association, or insurance company, keeping accounts upon any basis other than that of actual receipts and disburse

ments, unless such other basis does not clearly reflect its income, may, subject to regulations made by the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, make its return upon the basis upon which its accounts are kept, in which case the tax shall be computed upon its income as so returned.

This is the first time the law specifically recognized keeping accounts, for income tax purposes, on any basis other than that of receipts and disbursements, and even then no other basis was to be used if the taxpayer's income thereunder was not clearly reflected, and in no event was another basis to be used unless it was in conformity with regulations made by the Commissioner with the approval of the Secretary. Formal consent in each individual case upon application made to making returns of income on the basis upon which accounts were kept was not necessary. But there were two necessary requisites: First, the accounts must have clearly reflected true income; second, if a system other than receipts and disbursements were used, it must have been subject to regulations made by the Commissioner.

This Act was approved September 8, 1916, and shortly thereafter on January 8, 1917, Treasury Decision 2433 was approved by the Secretary. This Treasury decision, after quoting section 13(d) as above, reads as follows:

Under this provision it will be permissible for corporations which accrue on their books monthly or at other stated periods amounts sufficient to meet fixed annual or other charges to deduct from their gross income the amounts so accrued, provided such accruals approximate as nearly as possible the actual liabilities for which the accruals are made, and provided that in cases wherein deductions are made on the accrual basis as hereinbefore indicated income from fixed and determinable sources accruing to the corporations must be returned, for the purpose of the tax, on the same basis.

In cases wherein, pursuant to the consistent practice of accounting of the corporation, or pursuant to the requirements of some Federal, State, or municipal supervising authority, corporations set up and maintain reserves to meet liabilities, the amount of which and the date of payment or maturity of which is not definitely determined or determinable at the time the liability is incurred, it will be permissible for the corporations to deduct from their gross income the amounts credited to such reserves each year, provided that the amounts deductible on account of the reserves shall approximate as nearly as can be determined the actual amounts which experience has demonstrated would be necessary to discharge the liabilities incurred during the year and for the payment of which additions to the reserves were made; and provided if it shall be found that the amount credited to any such reserve is in excess of the reasonable or probable needs of the corporation to meet and discharge the liabilities for which the reserve is credited, the excess of such reserve over and above the reasonable or probable needs for the purpose indicated shall be at once disallowed as a deduction and restored to income for the purpose of the tax; and provided further that in no event will sinking funds or other reserves set up to meet additions, betterments, or other capital obligations constitute allowable deductions from gross income.

This ruling contemplates that the income and authorized deductions shall be computed and accounted for on the same basis and that the same practice shall be consistently followed year after year. Amounts paid in discharge of any liability or obligation for which a reserve has been set up, as hereinbefore outlined, will, when paid, be charged to the reserve created to meet it in so far as such reserve is sufficient to meet the liability, provided always that the liability is of a character which constitutes an allowable deduction within the meaning of the law.

If upon investigation it shall be found that returns made upon the basis of accruals and reserves do not reflect the true net income, the corporation so failing in this way to return the true net income will not thereafter be permitted to make its returns upon any basis other than that of actual receipts and disbursements.

The reserves contemplated by the foregoing ruling are those reserves only which are set up to meet some actual liability incurred, the amount necessary to discharge which can not at the time be definitely determined, and do not contemplate reserves to meet losses contingent upon shrinkage in values, losses from bad debts, capital investments, etc., which losses are deductible only when definitely determined as the result of a closed or completed transaction and are charged off.

The company contends, notwithstanding section 13 (d) and Treasury Decision 2433, that the wording of the statute, "Taxes paid within the year" precludes their deduction in any year except that in which they were actually paid. If this be true, we have a peculiar and anomalous situation in connection with the company's returns. It admits, and its returns so show, that the ordinary and necessary expenses incurred within the year 1916 in the maintenance and operation of its business and property, provided for in the first subdivision of section 12 (a), were accrued on its books and deducted in its tax return for 1916, whether or not such expenses were actually paid within that year. Likewise, all items of income, whether or not actually received, were accrued and included in gross income. So far as the statute is concerned, there is nothing to indicate that the expenses referred to in the first subdivision of section 12(a) should be accrued and deducted as accrued, and that taxes referred to in subdivision 4 thereof should be deducted only in the year in which paid. The word "paid" is used in identically the same manner in both subdivisions without qualifying words, and according to rules of statutory construction the deductions classified thereunder must receive like treatment.

There would be great force to the argument that the wording of the statute "Taxes paid within the year" precludes their deduction in any year except that within which they are actually paid were it not for section 13(d). In construing a statute, full consideration must be given to all its provisions, and a construction adopted that will permit all sections to harmonize if possible. In framing the Revenue Act of 1916 it was contemplated, as theretofore, that accounts ordinarily were kept on the receipts and disbursements basis; hence the use of the word "paid" in connection with all items of deductions enumerated in section 12(a). But desiring to recognize other systems of keeping accounts, section 13(d) was inserted, which was designed especially to recognize the system of accrued accounting; that is, that all items of income and outgo be either actually determined or estimated as they accrue and that the proper entries be made upon the books at that time, returns of income be made on that basis, and the tax paid accordingly. To this extent, then, section 13 (d) is a qualifying section, and when accounts are kept on the accrual basis, so as to bring the taxpayer within this section, it qualifies the word paid" and the manner of making deductions allowed in section 12(a). The word "paid," therefore, is to be read "paid or accrued," depending on how the accounts of the taxpayer are kept.

It is further contended by the company that it did not accrue munitions taxes, but only set up a reserve to meet this liability, the amount of which was not definitely determined until some time in 1917, and even if these taxes were accrued on its books it is still proper, in view of the wording of the statute, and the fact that Treasury Decision 2433 merely gives corporations permission to use the accrual basis.