ness of a corporation; that is, the one hundred per cent ownership; the beneficial ownership of everything that enters into the property of the corporation, including capital stock, surplus, undivided profits, tangible property, good-will and other intangibles; its capacities and prospects; in short, every element that gives it an important present or prospective value.

It is interesting and instructive to note the different viewpoints brought out in correspondence and discussed in the many interviews with taxpayers and their representatives. In one case it will be claimed that the capital and surplus is the only index of fair value, for the law requires that the surplus and undivided profits be included; another, that the market affords the proper basis, since it indicates due consideration of all factors and is the opinion of numerous investors as to the intrinsic worth; and a third, that the earnings should be the only guide, as this is the determining factor in arriving at the worth of an enterprise, and is the controlling factor in a purchase or sale.

If the taxpayer will be as fair as the government is in endeavoring to reach conclusions in accordance with the facts, little difficulty should be experienced in arriving at a satisfactory basis.

The impossibility of establishing fixed rules or methods for the determination of fair value, embracing every possible line of business, is apparent and usually recognized. Any single scheme or formula will necessarily have its shortcomings, if applied to all corporations. No fixed basis or method is applicable to all companies and even the same method may not apply year after year. The problem must be approached from all angles in a spirit of fairness. It is important, therefore, to secure as auditors a different type than is implied in the ordinary sense of the word; that is, men of sound judgment and of a judicial temperament; of an analytical turn of mind, having a general knowledge of business conditions, some knowledge of law, of accounting practice and financing procedure.

The three exhibits of the form upon which the return is made are considered a means of supplying uniform information by all corporations, and such data constitute supporting evidence for use by the bureau in checking the fair value reported. Corporations are invited to attach additional exhibits or statements of pertinent facts relied upon to support the valuation claimed.

Exhibit A-the balance sheet-values over or understated on the books may be adjusted in the "fair value" column to fair market value, if accompanied by a satisfactory and acceptable explanation that clearly sets forth the justification there for. The nature of the business and character of the assets are the most important factors in determining the reliability of the value reflected by this exhibit.

The balance sheet, subject to any necessary adjustment, affords a sound starting point. Many asset items need no adjustment; some may readily be adjusted on the basis of market value; others are more or less dependent upon earnings. Intangibles, such as goodwill, often constitute valuable assets, which may be determined by saleability or any excess of earnings over and above a fair return upon the investment. If the market value of an asset can be established, as in the case of an apartment house or timber land, it makes little difference as to the earnings. The earnings may or may not reflect the value of the entire assets. All holdings of a company must be considered and it should be noted whether any non-productive or non-income-producing property or securities are included. The earnings may only reflect the value of that portion of the assets used in the business. Assets depreciated in conformity with income tax requirements, often have a fair value considerably in excess of depreciated value. Public utilities, manufacturing and similar companies may have large investments in Liberty bonds or low-dividend-paying, high-class securities that do not require as high a rate of capitalization as would be necessary in establishing a plant value. Failure of such companies to earn a fair return on the investment indicates an excessive capitalization, something questionable in the management, excessive salaries, disproportionate expenses, or some unusual condition affecting the company. Under these conditions, it is difficult and often impos sible to adjust the balance sheet to fair value except arbitrarily or through earnings; while in the case of a new business the earning capacity has not been established and therefore has little bearing.

Cost is not always the same as value, but is evidence of value. Value involves not only a concept of the present, but also of the future. Liquidating value is generally considered a minimum fair value.

Exhibit B-the market: To this exhibit the earlier regulations attached the greatest importance. It is now regarded as having a bearing, but only of importance where the underlying factors upon which the market has been established are sound in all essential particulars. Different classes of stocks sell on considerably different bases, as regards assets, stability of earnings, and investment yield. Thus there is a large variation between stocks in public utility, mining, motor, steel, shipping, and textile companies. Manipulation plays an important part in many instances. Control rarely changes at listed prices, and this factor should not be overlooked in using the market price as indicative of fair value of the entire capital stock. The value of many stocks depends to a large degree upon the control over other concerns which the ownership of the stock gives; as, for example, minor railroads with important connections, and the like. The advantages resulting from this.

control are often not reflected in the investment yield or stability of earnings of such companies. One element in the market price of any security is its marketability. Comparison of listed stocks shows that a stock with a wide and active market will often command a better price than a stock without such market. The size and general reputation of a company has much to do with the value of its securities.

Par value of the capital stock of a corporation is a rather arbitrary matter. It is notorious that in many large corporations, and also in many smaller ones, a large percentage of the common stock is water.

An actual bona fide sale of from fifty-one to one hundred per cent of the entire capital stock of a corporation may hardly be disregarded, but an active market may only reflect a large turn-over of a small number of shares, representing the floating supply. To Justify a refusal to accept the market there is generally an explanation, such as manipulation, large earnings with an utlra-conservative dividend policy, prospects favorable or unfavorable, or unusual conditions. In many instances the market affords the only reliable basis, as in the case of a promotion company, with an active market and assets of highly speculative value, or where a sale price is established by an underwriter. Where manipulation is evident the market is unreliable.

Exhibit C-the net income: This is a theoretical determination of a valuation, and the application of any theory requires the exercise of great care. The weight attaching to this exhibit is also largely dependent upon the nature of the business and the character of the assets.

Two important factors are involved in a proper consideration and interpretation of exhibit C; first, the proper earnings to be capitalized, and second, the rate to be used in capitalizing. It is as difficult to determine the true earning capacity as it is to decide the rate of return.

Average past earnings under normal conditions simply indicate what may ordinarily be expected in the future. It would be unfair and illogical to use for the purpose of capitalization and as the controlling factor in determining fair value, earnings abnormally high or low in the case of corporations advantageously or adversely affected, while the country was engaged in war. The bureau has given this condition careful consideration and in every instance has endeavored to permit adjustments that appeared warranted. It seems reasonable to assume, however, that the value of the capital stock fluctuates with the conditions in the business, and the tendency is for increased value during prosperous years and vice versa.

Also, in capitalizing past earnings, there should be regard for

the prospects of the business. Extreme illustrations of this would be breweries legislated out of business; oil, mining, or timber properties nearing exhaustion; or the securing of a large contract or order on very favorable terms.

In recent years the writing down of inventories has resulted in losses for a particular year, but such losses do not indicate the true earning power of the company.

If asset values are being depreciated on an inflated or excessive basis, the net income is materially reduced. Where a corporation increases its capital, it is reasonable to suppose that the earnings will increase proportionately, so that past earnings on the lower capital are not controlling in determining the earning capacity of the increased capital. The years to be considered should be comparable with current conditions.

The wide variation in rates used by corporations in their returns, for capitalizing the adjusted average income indicates that in many instances the rates are selected arbitrarily, to establish a valuation comparable with the market or the book value. It does not require as high a rate to support sound asset values as it does to introduce a good-will value.

The chief factors in determining the rate for the purpose of capitalization are certainty of income and risk. The element of risk varies widely between different kinds of business and may even vary in different companies in the same business. Considerations are whether the products are luxuries or relative necessities; whether earnings are regular, indicating stability; increasing, indicating prospective development and prosperity; decreasing, indicating depression or slowing down of business and losses, indicating serious conditions; and greatly fluctuating, indicating unreliability and generally greater hazards. Large increases or decreases should be explained. So, according to the nature and hazards of the business, the amount and nature of the assets, the consideration of a fair interest return, the cost of borrowing money or underwriting securities, the compensation for management, the policy as to dividends, depreciation and upkeep to maintain the original investment unimpaired, and incidentally the bonded indebtedness, the rates should necessarily vary. Many of these factors, according to the system of accounting employed, are eliminated through the operating account.

To apply a given rate in a case of decreasing and increasing earnings having the same average over a five-year period, would establish the same value, with entirely reverse conditions prevail. ing. The result would be a possible advantage to one company and an injustice to the other, which illustrates the impracticability of contending that any fixed rate for capitalizing may be employed. Therefore, the rate is largely dependent upon the peculiar circum

stances surrounding each individual company and the economic factors affecting the particular industry.

To arrive at fair value, possibilities and probabilities, as well as things certain, are properly considered, but it is apparent from the foregoing that in the case of most corporations, under normal conditions there is a point at which the information called for by the bureau is harmonized into what may reasonably be considered the fair value of the capital stock.

With respect to parent and subsidiary companies, each corporation is treated as a separate entity. However, it is a common contention that a group of corporations is in reality one business and to tax each company within the group is double taxation. After deliberate and careful consideration, the bureau has reached the conclusion that under the provisions of the law as it now stands, each corporation is liable to the tax if it is engaged in business.

In conclusion, it is believed safe to state that under the present regulations, policies, and methods of procedure, the law is being administered with as little annoyance and differences of opinion as can be expected. In support of such statement, reference is made to the small number of protests, appeals for review, and claims received as compared with the total number of returns filed.

I wish to express my thanks and appreciation for the invitation to attend this conference, and both the commissioner of internal revenue, the Honorable David H. Blair, and deputy commissioner, McKenzie Moss, desire to request continued sincere cooperation on the part of the taxpayers and their representatives, and assure you all of the same on the part of the bureau.

CHAIRMAN WHITNEY: Mr. Drake, will you kindly express to the commissioner and the deputy commissioner our great thanks for your being here. We certainly appreciate this co-operation and we shall endeavor to co-operate with you.

MR. DRAKE: I shall be very glad to do so.

CHAIRMAN WHITNEY: Gentlemen, this discussion is not confined to the federal capital stock tax, but we have a good many troubles in the administration of the state capital stock taxes. The matter is before you for discussion, both phases of it.

MR. E. E. WAKEFIELD of Massachusetts: I should like to ask Mr. Drake a question with reference to the use of Exhibit A on net assets, in the valuation, whether in fact a great majority of the valuations are not made in practice on the basis of the net assets and, if so, whether that is a practical administrative matter, or whether it is the view of the bureau, that value is in the majority of the cases best indicated by the net assets.

MR. DRAKE: I feel, as I stated in my remarks, that the balance