SECTION 38. and in a way that they consider is for careful administration. In other words Mr. JAMES. Under the Democratic administration they don't doubt it? Mr. HILL. And so you have made these criticisms and believe that everybody is willing to pay if assured that the money will be spent purely for Federal matters and not for the improvement of localities merely. In other words, the entire number would pay the tax we are proposing to have them pay if the money were used in a truly public manner or for some great national purpose? Mr. MONTGOMERY. Yes, sir; if used properly. Mr. JAMES. As, for instance, prosecution of the trusts and all such things? I understand there is a very marked change in regard to the payment of the tax. pre Mr. MONTGOMERY. It is under favorable consideration almost universally. It is surprising to the accountants when we get together, as we do, and having experience with the corporations, to note expressions as to how they will pay this tax. But there is one inequitable feature, not large, but it is inequitable. It is felt that the law should be based on more than one year's operations. It should be, as we believe, based on the income which is an average of the ceding three years. In other words, a certain manufacturer may in 10 years make $1,000,000, and another one may make the same amount; but one in the course of that time may pay only $10,000 income tax, and the other $20,000 tax. The reason for that is that there are certain fluctuations that are almost invariable in the estimating of income at the end of a certain period. Large inventories are of course largely affected, and markets and prices have to be taken into consideration. I know a house that year before last paid on the basis of a $60,000 profit. The next year, through changes in the market, it had a loss of $40,000. It paid the Government $600, and the following year it lost $40,000. And he got no rebate. Now, that should be avoided. This is not much loss to the Government; it evens it up over a period of time; and I believe in other countries where there is an income tax and has been for many years it is found to be equitable. Mr. JAMES. Well, now, the proposition that a man may be able to pay a good deal this year, and may not have anything next year, applies to all people, doesn't it? Mr. MONTGOMERY. There is no certain thing for a man with reference to this tax. He may have assets that he has not yet realized and on which he pays an excess tax. Now, when he comes to realize on it it is an overpayment just the same as any other overpayment made to the Government. Mr. LONGWORTH. You speak of the English system of averaging up the tax for three years. How do they do it when they change the rate almost every year? Mr. MONTGOMERY. Well, they assess the profit for the preceding three years and apply the current rate. That is perfectly fair. Mr. JAMES. You say you have talked to a great many people on the subject? Mr. MONTGOMERY. Yes, a very great many-boards of trade and chambers of commerce and other organizations all over the country. SECTION 38. Mr. JAMES. Well, how is it you didn't sound them on what the exemption ought to be? Mr. MONTGOMERY. Well, as to corporations I think the exemption is reasonable. Mr. JAMES. Well, as to the individual? Mr. MONTGOMERY. There is a very general feeling that it ought to be very small. Mr. LONGWORTH. And how would you settle on a figure? That's a very important thing. What assessment or figure would you say should apply, bearing in mind that in other countries, such as England, they have been estimated or fixed? In England it is incomes of more than $1,000, in another country $800, in Germany a little over $1,000, which is the highest, all the others running down. Now, what do you think it ought to be? Mr. MONTGOMERY. It would be under $2,000 if we were to have a law in force like most of the countries, from what I have heard. Mr. FORDNEY. We got it on $600 in the Civil War, didn't we? Mr. JAMES. Would that be a fair proposition, considering the fact that there is no other class of people who would be affected-to pay so much to keep up the Government as they do? Mr. MONTGOMERY. Well, they're paying it now in another way, and hope to be relieved through the present administration; and they are willing and prepared to pay it in this way. Mr. JAMES. Yes, I know; but under our Federal Government the poor people pay as much, you might say, to keep up the Federal Government as a man who has many hundreds of thousands of dollars, because it is practically a consumption tax. Mr. MONTGOMERY. Yes, that's true; and if the present high cost of living continues, why I should say that the exemption might be fairly high. The CHAIRMAN. Your time has expired, Mr. Montgomery. EVIDENCE PRESENTED ON THE ADMINISTRATIVE FEATURES OF THE PAYNE-ALDRICH The American Association of Public Accountants is the national organization of accountants in all parts of the country, and represents a large majority of the practicing profession. Our sole object in requesting a hearing before this committee is that we may be able to render such assistance as from our wide and practical experience we feel that we are qualified to render. Our experience covers governmental as well as commercial activity. While it is true that many of our clients are corporations, yet it is proper to state that during recent years we have been retained by Federal, State and municipal bodies, as well as by civic and other quasi public organizations. Our attention, therefore, is drawn to the subject of taxation by those who levy as well as by those who pay. For this reason our attitude is strictly impartial. As a body we are not concerned with the principle of this tax nor of any other, but inasmuch as the making of returns for the purposes of taxation falls largely upon the shoulders of public accountants, and because we stand in a fiduciary relation to a large number of the taxpayers, we believe that our opinion is of value. I maintain that wherever possible every concession should be made to the taxpayer so long as such concessions do not interfere with the purpose of the taxing law; and for this reason I urge that in all legislation affecting finance and accounts the professional accountants of the country may have a chance to express their opinion and to advise legislators as to the practical side of the legislation which they have before them. Furthermore, it will be apparent to any one that the SECTION 38. law which is most easily understood and most easily applied will bring the most satisfactory results to the Government. In the case of the excise tax on corporations the members of your committee are fully aware that the provisions of the law were found unworkable and the Treasury Department's rulings have been at wide variance with the letter of the law. This divergence has been rendered necessary, as otherwise the law could not have been applied. It might be well to consider the desirability of authorizing the Treasury Department to formulate regulations hereafter, as it has actually in the past, except that in such case the law itself need not go into details as to how net income is to be determined. As a matter of fact, it is almost impossible to so define net income or net profits that all classes of enterprises will be subject thereto. For instance, mining companies and trading companies have different problems to meet, and if the Treasury Department were empowered to issue instructions modified to meet varying conditions there would not be so much dissatisfaction with the administration of the law as now exists. For the purpose of record, and in order that the matter will not escape attention when, and if, the present tariff act is amended, I desire to discuss certain other objectionable features of the existing law. I call attention first to the provisions of the law which provide that the tax shall be charged upon the entire net income of corporations, and that net income is to be ascertained by deducting from the gross amount of the income from all sources expenses actually paid, losses actually sustained, interest actually paid, in each case within a year. The words "actually paid" convey but one meaning to those who are versed in financial and commercial affairs, and that is the actual disbursement of money, either currency or bankable funds. Naturally, those who wish to comply with the law have a just grievance if they are informed that these words have one meaning when they appear in a Federal statute, and another meaning at all other times. We maintain that the phraseology should have been: "Expenses actually incurred" because the payments are not necessarily, nor in fact usually, all made in the period in which the expenses are incurred. "Losses actually ascertained" because losses may accrue and the amount not be ascertained until a subsequent period. "Interest actually accrued" because interest is not paid until the end of the period during which it accrues and the interest accrued is the proper charge against income. The act is confusing also in that it refers at one time to net income received, in another to gross income without the addition of the word received, and in another paragraph to gross income received. This complication of terms naturally leads to endless confusion. Our suggestion is that there are two methods which may be adopted for taxation purposes; either to tax the difference between actual cash receipts on revenue account and actual cash payments on revenue account, which difference will seldom, if ever, represent the profits of a manufacturing concern, or to tax profits made up in the ordinary commercial way, namely, to ascertain the gross income earned whether received or not, and to deduct therefrom: Expenses actually incurred during the year whether paid or not; losses actually ascertained and written off during the year whenever incurred; interest accrued during the year whether paid or not; a reasonable allowance for depreciation of property; and taxes. We have found that the corporations as a whole look upon the tax as an equitable one except as to the unnecessary annoyance and expense hereinbefore indicated, and with the further exception that it works a hardship in a few cases where profits are difficult to determine. For instance, a corporation which makes a large apparent profit one year may find during the succeeding year that the previous year's profits were largely overestimated and that the adjustment thereof results in a loss sufficiently large to show a net loss for the year. The Government has received its 1 per cent upon the profit, subsequently discovered to be erroneous, but grants no relief, although an honest mistake has been made in the payment. This condition is not extraordinary; the values placed upon the assets appearing in a balance sheet are necessarily estimates, and are based upon conditions which change rapidly and for many different reasons. Corporations engaged in businesses affected by the tariff may value their inventories at a market price on December 31, which proves to be largely in excess of the actual price which can be realized in April. If a tax has been paid in good faith, based upon the best available information to December 31, there should be some adjustment possible when the inventory is reduced to cash. The solution of this inequitable feature of the present law which is found in the British income tax practice, and which works no hardship upon the Government, is to base the tax upon the average result of the last three years' operations immediately preceding the taxing date. In the case of nearly all corporations the income to the 78959°-VOL 6-13 -35 SECTION 38. Government would be the same as it is now, but as to a few corporations the tax would be somewhat less. It is urged, however, that the trifling loss to the Government would be more than compensated by the universal approval which would be extended to that taxing power, which, through a provision such as has been suggeated, indicates to those paying the tax that it desires to deal fairly with them. In view of the fact that an income tax has been levied in England for more than 50 years it is obvious that valuable experience has been gained, of which we should take full advantage. We have among our members accountants who have had wide experience with the practical workings of the British laws, and their advice and suggestions are at your disposal. In conclusion I suggest that wherever the machinery of Federal administration can coordinate with honest and efficient business methods simple justice requires that the laws specifying the machinery be skilfully drawn. I would state, as I did when speaking before this committee on January 10, 1912, that the American Association of Public Accountants, from its close connection with all classes of business, is in a position to offer indispensable services and that we shall always be ready and glad to render every assistance in our power to further the preparation of efficient legislation. We do not desire to appear as destructive critics, but as honest collaborators with those to whom the making of the laws is entrusted. EVIDENCE OFFERED BY ARTHUR Young, CertIFIED PUBLIC ACCOUNTANT, CHAIRMAN OF THE COMMITTEE ON FEDERAL LEGISLATION OF THE AMERICAN ASSOCIATION OF PUBLIC ACCOUNTANTS AND PRESIDENT OF THE ILLINOIS SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS. I appear before your committee for the purpose of offering for its consideration the advisability in levying any corporation tax of allowing corporations to make their annual returns based on their fiscal year, irrespective of whether that fiscal year may happen to be December 31 or not. The main consideration in behalf of this policy is the fact that the Government will not suffer any diminution of revenue, while on the other hand it will confer great advantage to the business community. A large number of corporations can close their year quite readily at December 31, but a very great number can not do so without great inconvenience and large expense. The main reason for this is that the taking of inventory is a matter of the utmost importance in ascertaining the profits. All conservative companies try to take their annual inventories at the time when their stock in process of manufacture, or their raw-material stock, is at the lowest amount, the reason for this being that a more accurate inventory can be taken and the possibility of errors be avoided. In addition many corporations that have to take inventories in the open air can not make their employees do this work in the severe weather and have to wait until a milder season of the year; other corporations are at their very busiest period at Christmas time and can not give the time to take the inventory without suffering severe financial loss. A factory has usually to shut down in order to take inventory. It therefore aims to do this at the slackest time of year. It is suggested that the Government would be less liable to errors by the corporations if each corporation were allowed to close its year and take its inventory at the time of year when its stock is lowest and when for other reasons it has most time available for closing its business. The above points can be illustrated from a few typical industries. In the glass industry of this country, which is of enormous extent, it is necessary because of summer heat to close down the factories during the two hottest months of the year. Almost every one of these companies takes advantage of this opportunity to make up its inventory and close its business. Such corporations suffer loss and inconvenience by taking an inventory on the 31st of December. I believe many of them make their returns to the Government on an estimated inventory December 31. It would, of course, be much better to have their year close on the date of the actual inventory. In the case of many blast furnaces, they have enormous stocks of iron ore on hand in wintertime. This is especially the case with blast furnaces situated on the Great Lakes, as they get their heavy supplies just before the close of navigation. The conservative corporations in this line of business prefer to take their inventories in spring. or summer time, when the stock of iron ore is practically used up and when the esti SECTION 38. mates of amounts of iron ore on hand can be readily and accurately made. When many thousands of tons of iron ore are stacked up in the yards it is almost impossbile by measurement, owing to the difference in weight, to ascertain the exact value of the iron ore no matter how much this may be helped by chemical sampling. It, therefore, makes for accuracy if such concerns can take their inventories when their iron ore is at the lowest. Almost every department store in the country has its busiest time at the end of the year. They have just finished their Christmas trade and are preparing for their January sales, which open on the 2d of January. The practical result is that most of them take their inventory about February 1, just after the January sales are finished and before the spring trade begins. It is in many cases absolutely impossible for them to take an inventory on the 1st of January, therefore I presume in making their returns to the Government most of them must use estimated inventories. In this case it would also make for accuracy and certainly for the convenience of business if such corporations were allowed to choose their annual closing period themselves. Similar considerations apply to the elevator and grain companies, especially in the northwest. They are in the middle of their busy season at December 31. Almost all of them find it advisable to wait until later in the year before taking stock and closing their business. In the automobile business early winter is the busiest time for manufacturers. At December 31 their works are filled with half-manufactured goods and half-completed machines. If they are to ascertain their profits correctly it is almost necessary for them to wait as most of them do either until summer or autumn when they have few automobiles in process and can make up their inventory largely from raw material, the prices of which can be readily ascertained, and from fully manufactured machines. Many of them have in the busy season millions of dollars' worth of half-manufactured goods. If this has to be estimated for inventory purposes at that time wide errors are apt to arise. Similar remarks apply to most of the agricultural implement makers of the country. Winter and early spring are their busiest times for manufacture, and it is often a hardship if they have to shut down their works and take inventory December 31. In the lumber industry it is in many cases impossible to take an inventory in the depth of winter. The weather in many instances makes this physically impossible. The result is that according to the different climate in various parts of the country lumber companies take their inventories at varying seasons, some of them in summer and others later in the year. The arbitrary closing on December 31 in this industry works hardships in many parts of the country. As regards railroads, there is a curious anomaly. The present corporation tax compels the railroads to close their year December 31, whereas the older authority of Interstate Commerce Commission has insisted upon June 30 being the time of closing for railroads. Much opposition arose against the Interstate Commerce Commission on this point, but in the past few years the commission has insisted upon railroads closing uniformly on June 30, which practice is now universal among railroads. Express companies are in the same class as railroads. It would therefore appear that these two industries have to conform to two different governmental bodies. So far as I have learned no final decision has as yet been given as to which of them they have to obey. It would appear advisable to have uniformity in this respect. The above instances are merely given as illustrations of a few of the classes of activities that are hampered by an arbitrary closing on December 31. In favor of allowing corporations, under proper regulation, to close their years at the period that suits them individually, it should be urged that thereby corporations will be saved much annoyance and large sums of money and that more accurate profits will be arrived at when the true inventories can be taken than when annual accounts are made upon estimated inventories of December 31. The corporation tax is collected by the Government at a less expense than any other of our methods of taxation. It would seem that in levying this tax the Government should not make it a hardship on the people that pay it, but should take every reasonable means to have it paid with the least possible inconvenience and expense being imposed upon those who furnish this revenue for the Government. |