always have been accepted as the basis of taxation, subject to minor provisions as to rates of depreciation, interest deductions, etc.

Our main criticism of the bill in its present form is that in the large majority of cases it will be impossible of application for the year 1909, as explained in our previous letter, and very difficult and expensive, if not altogether impossible, in subsequent years.

Railroads perhaps require the simplest form of accounting obtaining among business corporations. These accounts are kept in a form prescribed by the Interstate Commerce Commission, and severe penalties can be inflicted for any departure from those forms. They must be kept on a basis not of Receipts and Disbursements, but of Earnings, whether collected in cash or not, and of Expenses, whether paid or not, which in both cases accrue during the fiscal year closing on June 30th, the outstanding Income and Expense items uncollected and unpaid running into very large figures and frequently varying considerably in amount between one year and another. While it would be possible to prepare also an account of Receipts and Disbursements, this would involve a great deal of extra work in the compilation of special data and would raise most difficult questions as to the proper distribution between Capital and Income of large payments for stores, the ultimate use of which is not and cannot be known at the time of payment.

Turning now from this, which is perhaps the most simple case, to that of a large manufacturing concern producing all kinds of finished products out of purchases of ore and other raw materials, an accurate or even approximate statement of Cash Receipts and Disbursements on Income Account is a practical impossibility at any time. Cash Receipts arising from sales of products can be ascertained without much difficulty beyond requiring considerable extra work. But no system of accounting can give even approximately "the ordinary and necessary expenses actually paid within the year out of Income in the maintenance and operation of its business and properties." Such expenses presumably must include the cost of the goods sold. Into this cost, and following it through all the intricate accounting which has been found to be necessary, are raw materials actually used in manufacture, labor expended, and innumerable items of expense which are taken into costs as they accrue, quite irrespective of the date of payment. Very large inventories are carried of materials and supplies which are purchased at one period, paid for at another, and used at all sorts of times, in all sorts of quantities, and for all sorts of purposes, mainly for manufacture into products for sale, but to a large extent for additions to or extensions of the plant. Such as are used for the latter purpose are not, as we understand the proposed law, a proper deduction from Gross Income, and yet long before they are used all identity between the materials themselves and the disbursements made for them has been lost. There is, in our opinion, no method by which any such statement as that called for in the proposed law can be prepared short of an entirely independent and separate set of books, designed to follow each bill paid through to the ultimate destination of the materials or services covered

thereby, thus duplicating the present cost of the Accounting Department and serving no useful purpose whatever. Even if such method were adopted, it is very doubtful if it would produce the results required with even approximate accuracy.

Without unduly burdening this letter, it is impossible to go into further details here; but the facts must, in the opinion of any one familiar with the operations and accounts of a complicated modern manufacturing concern, fully justify the conclusions which we expressed in our letter of July 8th, and which we now emphatically indorse. Whether the proposed method is physically impossible, or merely, as you state, "inconvenient," it will, we think, be generally conceded that it is in the general interest of the effective administration of laws relating to taxes that they should involve as little inconvenience as possible upon those required to make returns thereunder. The basis for arriving at the amount liable to taxation suggested in our former letter would have the advantage of simplicity, and if the tax is to be a permanent institution, its efficient operation would be greatly facilitated by conformity with regular accounting methods.

We have felt it our duty to protest strongly against the wording of the proposed bill upon the grounds set forth, but our object is to help, and not to hinder. If you think any good purpose would be served by our appearing before you and discussing this matter fully with a view of arriving at a satisfactory solution, which we are satisfied can be done, we shall be pleased to hold ourselves at your disposal for this purpose.

Regretting our inability to in any way modify the conclusions already expressed, We are, Dear Sir,

Yours very truly,

(Signed by eleven firms of accountants.)

The Attorney General's reply to the second letter of the accountants was as follows:

DEAR SIRS:

WASHINGTON, D. C., July 22, 1909.

I have a letter dated the 21st instant, signed by yourself and a number of other firms of accountants, in response to my letter of July 12th, replying to your former letter of July 8th. In your last letter you set forth in somewhat more detail the following proposition:

"But no system of accounting can give even approximately 'the ordinary and necessary expenses actually paid within the year out of income in the maintenance and operation of its business and properties.'”

I think the bare statement of that proposition would be received with very great incredulity by most minds. Certainly, I am quite unable to assent to it. However, it is now too late to attempt to recast the corporation tax amendment bill on the basis of such proposition.

Respectfully yours,

(Signed) GEORGE W. WICKERSHAM, Attorney General.

A glance at the text of the law as it stands on the statute books will show that in spite of the protest of the accountants, who in this case were the men best qualified to judge of the workability of the law, the bill was allowed to pass in its awkward and unworkable form. Those interested in the subject should compare the law with the accountants' letters and the Treasury explanations. It will be found that the position of the accountants was fully confirmed although no recognition of this fact has been made. The Treasury Department practically rewrote the law, thus proving its impracticability. Out of this have resulted some interesting incidents. Where litigation is resorted to, the court follows the law-not the interpretation thereof by the Treasury. Probably nine-tenths of the returns would, or could be altered if the law were followed instead of the prescribed forms.

For some time after the passage of the act the Treasury Department, which was intrusted with the collection of the tax, and the Attorney General's department, which was responsible for the wording of the law, were unable to agree as to the method of collection, the exemptions to be allowed, and the calculation of net profits.

While things were in this chaotic condition in the Government offices, corporations were equally undecided as to what returns were desired and what amount of taxes each would be called upon to pay. Shortly after the passage of the act, however, the Treasury Department issued an explanation of the law and the regulations which would be laid down for its administration. The text of this explanation follows.

Corporation Excise Tax

PREPARATION OF BLANKS AND REGULATIONS

In the preparation of blanks and regulations for the administration of the Corporation Excise Tax, provided for in section 38 of the tariff act of August 5, 1909, the first question was to ascertain the real intent of the law. After ascertaining the real intent of the law, the problem was then to so prepare the forms and regulations as to carry out that intent and at the same time avoid, as far as consistent, unnecessary and unreasonable interference with ordinary practices of business. The standard adopted in making the regulations was that they should be fair, just, and reasonable to the taxpaying corporations as well as to the Government.

A study of the act discloses clearly that the intent of the law is as follows:

I. That the law is a revenue measure and should be construed liberally for the purpose of producing revenue for the Government.

2. That the real intent of the law is to collect a tax of 1 per cent on the net income, less $5,000, of the individual corporation, joint stock company, or association, liable to the tax.

In order to clearly understand the intent of the law a few primary definitions are essential:

NET INCOME

The term "net income" as used in this law means not only net profits arising from the operation of the principal business of the corporation, but all items of income received from other sources, such as investments, holdings in other companies, and businesses, etc. The expression "net income" is used because there can be no question as to its embracing amounts of income received from these outside sources, whereas there might be some question as to whether or not such items would be inIcluded in the expression "net profits" or "net earnings."

GROSS INCOME

In the same manner the term "gross income" includes gross profits, the expression being used because there can be no question but what it embraces all items of income received by any corporation from any source, while there might be some question as to whether "gross profits" or "gross earnings" would embrace such items.

A great amount of adverse criticism of this law is due to misapprehension of the proper definitions of these terms. The opinion was advanced that because "gross income" was not "gross profits" it must be "gross receipts," and that, in the same way, because "net income" was not "net profits," it meant "net receipts." An examination of the law, however, will show that if gross income meant gross receipts, the statutory deductions therefrom would not leave net receipts, but would leave merely an arbitrary sum. It also appeared from calculations that if these interpretations were given to the law from mercantile and manufacturing companies alone, the amount of tax received would be many times the sum which was estimated to be collected from all corporations, joint stock companies, and associations of whatever nature.

It is clear, therefore, that the purpose of the law was not to put a tax on receipts, but a tax on profits; and that the terms "gross income" and "net income" are used because, while they are practically indentical with "gross profits" and "net profits," they are yet more embrasive and consequently permit a more comprehensive administration of the law.

The law requires that the return from every corporation, joint stock company, and association liable to the tax shall show the "gross amount of the income . . received during the year from all sources," and authorizes certain deductions such as "ordinary and necessary expenses

actually paid out of earnings in the business and property of such corporations . . . within the year; all losses sustained during the year; amount of interest actually paid within the year; amount paid by it within the year for taxes; amount received within the year as dividends upon stock of other corporations liable to this tax, etc."

Very careful consideration has been given to these expressions in order to determine what evidence shall be required in order to determine what items are to be considered as “income" in calculating "gross income," and what items should be allowed as deductions under the language of the law. An impression has obtained in some quarters that no item should be considered in making up the account of the corporation, either as income or a deduction, unless its receipt or disbursement was evidenced by an actual cash transaction. It was owing to this interpretation placed on the law that a great number of accountants throughout the country declared that the law was impossible of administration, and if their interpretation of the law had been correct, there would indeed have been the most serious difficulty.

Upon first reading the law and studying the authorities relating to the language used, it would appear that the words admit of no interpretation other than that an item must have been evidenced by the actual disbursement of cash, or something of equal value, before it could be considered in making up the account of a corporation. It is interesting to note, however, that all definitions and decisions regarding the expression "actually paid," consider the matter from the standpoint of debtor and creditor, and not from the standpoint of the individual himself, or in this case, from within a corporation concerned solely with its own accounts from which alone the law requires this return for taxation to be made, and not taking into consideration the standpoint of the debtor.

It is clear that to hold that the phrase "actually paid within the year" requires evidence of actual disbursement in cash during the year would prohibit anything like accurate returns being made by any corporation, and would render it impossible to carry out what is the main purpose of the law, because to subtract from the gross income the deductions specified in the statute, calculated on a cash basis, would give net income, on which the tax is to be measured, only when the entire business transacted by the corporation is done in cash and the transactions are completed every day. It is not believed that there is any such corporation in existence. The return predicated on gross income received in cash and deductions represented by cash transactions, will vary from the real net income somewhat in proportion as the business transacted by the corporation varies from the absolutely cash basis.

This is viewing the matter in its simplest aspect. When we contemplate the complications and intricacies of the business affairs of a great corporation, with its many dealings with other corporations and individuals which are never settled in cash, but are settled on somewhat the clearinghouse plan; its many advances of funds and long-deferred statements of accounts, purchases of supplies and materials at one time, which are mixed