The Business Side of Holding 
 Out Income Tax on 
 Coupons, Etc. 
 
 Report of 
 
 Trust Companies Committee 
 
7b 
 
 Trust Companies Committee. 
 
 To the Trust Companies of New York City : 
 
 The undersigned Committee, appointed on March 21, 
 1913, to urge upon the Committees of Congress having 
 charge of the proposed taxation of incomes certain 
 features with respect to the collection of taxes under the 
 Act, begs leave to submit the following report : 
 
 Since the date of the organization of the Committee, 
 it has, with the assistance of its accountant and its 
 counsel, endeavored to bring to the attention of the 
 Committees of Finance in the United States Senate and 
 to the Conference Committee of the Senate and House, 
 to the members of the Committee on Ways and Means of 
 the House that had particular charge of the Income Tax 
 Law, certain recommendations with respect to the ad- 
 ministrative features of the Bill. The Committee pre- 
 pared a printed brief on behalf of the Trust Companies, 
 a copy of which you have no doubt received. 
 
 It is impossible, within the confines of a communica- 
 tion of this character, to enumerate the many provisions 
 to which this Committee called the attention of the 
 Committees of Congress, but the principal amendment 
 urged by this Committee was the adoption of the infor- 
 mation at the source,” in lieu of “stoppage at the 
 source,” as provided in the Bill. In this respect the 
 Committee was unsuccessful in its efforts before the 
 Conference Committee, although individual members of 
 both the House and the Senate expressed themselves 
 strongly as believing that the system advocated by the 
 Committee was preferable to that contained in the Bill. 
 
 In the original draft of the bill the provision relating 
 to the stoppage of corporate interest covered “bonds, 
 mortgages and other indebtedness” of corporations. 
 This would obviously have included among many other 
 matters, the thousands of deposit accounts in all the 
 banks of the country. Your committee made an espe- 
 cially serious effort to have this clause more clearly 
 
 1 
 
defined, and the Senate committee changed the passage 
 so that it now reads “bonds and mortgages or deeds of 
 trust and other similar obligations” — a very much more 
 restricted category and apparently what was actually 
 originally intended. 
 
 When the bill was in the Senate that body inserted an 
 amendment taxing non-resident foreigners. This taxing 
 would have been unfortunate, as this country is a bor- 
 rowing nation, and the investment of foreign capital for 
 the development of the country should be encouraged as 
 much as possible. Your Committee made strong repre- 
 sentations on this subject, and Congress was apparently 
 impressed with the wisdom of this policy and the Senate 
 amendment was stricken out. 
 
 Since the passage of the law the Committee has been 
 giving attention and study to the effect the law and the 
 Treasury Department regulations will have on trust 
 companies and general business. You have probably 
 seen the regulations just issued by the Treasury Depart- 
 ment, respecting the deduction of the tax on bond in- 
 terest which presented one of the most complicated 
 phases of the whole matter, and there is also sent you 
 herewith a statement prepared by Mr. Stuart H. Pat- 
 terson, the expert employed by your Committee, explain- 
 ing the business side of the regulations issued. 
 
 Your Committee believes that these regulations are in 
 the main satisfactory, and in certain respects accom- 
 plish what the Committee believe should be inserted in 
 the bill. The requirement that the certificates of part- 
 nership shall show the respective interest of each part- 
 ner in the bonds we, however, believe to be impractica- 
 ble and unnecessary, as under the law the authorities 
 can secure a statement of profits, etc., from every part- 
 nership and this information could be secured at such 
 time and make unnecessary a repetition of it on tens of 
 thousands of certificates of ownership. 
 
 The Committee will be glad to answer, as far as possi- 
 ble from its study of the Bill and regulations, any in- 
 quiries that may be put to it and will be glad to obtain 
 an opinion of counsel or accountants of the Committee, 
 
upon questions suggested by a Trust Company member. 
 
 Further reports if deemed necessary will be made to 
 you from time to time as additional regulations are is- 
 sued respecting rents and other matters. 
 
 Respectfully submitted, 
 
 Alexander J. Hemphill, 
 
 Chairman , 
 
 William B. Cardozo, 
 
 Otto T. Bannard, 
 
 Edward O. Stanley, 
 Calvert Brewer, 
 
 New York, October 27, 1913. Committee. 
 
Business Side of Holding Out Income Tax on 
 Coupons* 
 
 By STUART H. PATTERSON 
 
 The Treasury Department regulations just issued 
 relative to holding out the tax on bond interest, are clear 
 as to what shall be done from the Government’s point of 
 view, but an outline of the effect the regulations will 
 have on business conditions may be helpful to banks, 
 trust companies and corporations, and assist the Gov- 
 ernment in putting the law into operation with the least 
 possible disturbance to established business conditions. 
 
 The law provides the tax on bond interest shall be 
 collected at the source, but as anyone who has read the 
 act is aware, the law fails to define the source, so that 
 without specific instructions, any one of ten or fifteen 
 banks through which the coupons pass might feel that 
 in each instance they would be held responsible for the 
 collection of the tax and consequently in order to pro- 
 tect themselves, each might hold out the tax. Under the 
 Treasury Regulations the source is clearly defined, gnd 
 for all interest on the obligations of domestic corpora- 
 tions the debtor corporation (issuing company) or its 
 paying agent (if designated pursuant to the regula- 
 tions), is the source, except where the bondholder fails 
 to identify the class to which he belongs, by attaching 
 an Ownership Certificate to his coupons. In this latter 
 case the first person, bank or trust company purchasing 
 the coupons or receiving them for collection, becomes the 
 source and attaches to the coupons the name of the per- 
 son from whom the coupons were received so that the 
 Government will ultimately have a definite record of 
 those from whom the tax has been withheld. The Col- 
 lecting Bank also withholds the tax out of the proceeds 
 of the coupons. 
 
 Where income is from foreign countries, in every case 
 
 * This statement relates to the methods prescribed for November 1st and thereafter. 
 For special instructions from date to November 15th see bottom of page 11. 
 
 4 
 
the first person, bank or trust company receiving the 
 items, is the source. 
 
 The bondholders as mentioned in the regulations can 
 be grouped into four classes : 
 
 1. Citizens of the United States or resident foreign- 
 ers, who are exempt from taxation because their net 
 income is less than $3,000 or $4,000, according to status 
 of single or married. 
 
 2. Citizens of the United States or resident foreign- 
 ers, whose net income is in excess of $3,000 or $4,000, but 
 who are allowed exemptions up to a point of $3,000 or 
 $4,000, according to status. 
 
 3. Corporations, joint stock companies, associations, 
 etc., as fully described in paragraph G of the income 
 tax law. With respect to such organizations the law 
 provides the tax shall not be withheld at the source irre- 
 spective of whether or not the income is taxable. 
 
 4. Non-resident foreigners. 
 
 It will be seen from the above, that to carry out the 
 provisions of the law, of holding out the tax only on a 
 certain class of interest, it becomes necessary to identify 
 the coupons with the owner of the bonds and ascertain 
 the class to which the owner belongs, which can only be 
 done when coupons are presented for payment, because 
 when once paid coupons lose their identity. 
 
 Many debtor corporations are also interested in this 
 classification for the reason that a very large percentage 
 of the mortgages of corporations contain a provision to 
 pay the interest to the bondholder without any deduc- 
 tion for Federal tax, although the Government is not 
 interested in this feature one w T ay or another. 
 
 In order that the debtor corporations can keep this 
 covenant and at the same time assume the tax only 
 where an individual^ income is taxable, it is necessary 
 for the debtor corporations to know the class to which 
 bondholders belong and to what extent they claim ex- 
 emptions, as otherwise the corporations might be re- 
 quired to pay a tax to the Government on their entire 
 interest, which would be unjust and might lead to pro- 
 longed litigation. Under these conditions the corpora- 
 tions clearly have the right, before assuming the pay- 
 
 5 
 
ment of the tax of individuals, to obtain from them some 
 evidence that they are liable to taxation, and these 
 Ownership Certificates can be accepted for this purpose. 
 
 The plan of having Certificates of Ownership accom- 
 pany the coupons therefore accomplishes a two-fold pur- 
 pose. First, that of saving the man with a small income 
 the annoyance, possible expense and delay of securing a 
 refund of tax improperly deducted when he is not liable 
 to taxation and permitting every individual to claim 
 exemption up to at least $3,000 or $4,000. Second, in 
 permitting the debtor corporations to ascertain the 
 individuals claiming exemptions and thereby the extent 
 to which the tax must be assumed under the covenant. 
 
 It will be observed that the certificates required by 
 the regulations are not in the form of affidavits, as in 
 many cases the expense of securing an affidavit would 
 be as much as the tax would amount to. Congress un- 
 doubtedly recognized this fact and the law provides that 
 a claim for exemption, in a written statement, is suffi- 
 cient “and that thereupon no tax shall be withheld upon 
 the amount of such exemption,” but the penalties are 
 very severe for securing any deduction or exemption by 
 making fraudulent representations in these written 
 statements. 
 
 These Ownership Certificates eventually become part 
 of the records of the Government, hence the apparent 
 desire of the Government to secure in every instance a 
 certificate with the name and address of the bondholder. 
 
 Where an individual claims an exemption on one of 
 the Ownership Certificates, he fills in thereon the 
 amount of the exemption then claimed. To illustrate, 
 if the amount of coupons accompanying a certificate is 
 $100 and the individual claims exemption, he will fill 
 in $1.00 as the amount of exemption claimed on that 
 particular certificate. In the same manner he will con- 
 tinue to claim exemptions until he has reached the limit 
 allowed by law. Should he claim more exemption than 
 he is entitled to it will be known to the Government, 
 because no matter where these certificates are taken up 
 by the debtor corporations, whether in New York, St. 
 Louis or New Orleans, all of his certificates will un- 
 
 6 
 
doubtedly eventually find their way to the Collector of 
 Internal Revenue for the district in which he resides 
 and be assembled under his name. 
 
 All individuals should keep a record of the amount of 
 exemptions that they claim from time to time, so that 
 they will not inadvertently claim more than they are 
 entitled to in any one year. Under the law (Paragraph 
 D) the amount of exemptions allowed for the taxable 
 period ending December 31, 1913, is only five-sixths of 
 the amount allowed per annum. 
 
 We will now follow these certificates through the 
 banks, to the paying agents for the debtor corporations. 
 We will also first consider the case where the debtor cor- 
 poration has agreed to pay the interest without deduc- 
 tion for tax. The first certificate to come in is say that 
 from a corporation which owns some of the bonds of 
 the debtor corporation. The paying agent pays these 
 coupons in full, because under the law no tax is held 
 out against corporations, and places the certificate in 
 the exempt pile. The second certificate is by an indi- 
 vidual claiming exemption, or by a non-resident for- 
 eigner who is not subject to taxation, so his coupons are 
 paid in full and the certificate placed in the exempt pile. 
 The third certificate is that of a person who makes no 
 claim for exemption, but here again the paying agent 
 pays the full amount of the coupons, because in not 
 claiming the exemption, he is in effect admitting that he 
 has taxable income and consequently the debtor corpora- 
 tion performs its covenant and assumes the payment of 
 his tax by paying to him the full face value of the cou- 
 pon. Occasionally a Collecting Agent’s certificate will 
 come in, where the owner of the bonds has failed to at- 
 tach an Ownership Certificate to his coupons, but here 
 again the debtor corporation pays the full face value of 
 the coupon because in such cases the first Collecting 
 Bank withholds the tax. It will therefore be seen that 
 in all cases where the mortgage contains this covenant, 
 the entire amount of the coupons is paid by the debtor 
 corporations as formerly. While in the case of mort- 
 gages with the covenant no deductions are actually 
 made by the debtor corporation, it is nevertheless re- 
 
 7 
 
sponsible to the Government for the amount of the tax 
 of taxable persons, in the same manner as if it had ac- 
 tually withheld the tax when paying the coupons. The 
 paying agent will place the certificates of taxable indi- 
 viduals in a separate pile, and when totaled, the certifi- 
 cates will show the amount of tax deductions for taxable 
 persons. Before the twentieth of the following month 
 the debtor corporation or paying agent is obliged to 
 deliver the certificates together with a list to the Collec- 
 tor of Internal Revenue, and will probably prepare a 
 statement somewhat as follows : 
 
 X. Y. Z. R. R. CO. 
 
 General Mortgage 4% Bonds out- 
 standing 
 
 Interest on same for six months. . 
 Interest remaining unpaid at time 
 of last statement 
 
 Interest now remaining unpaid. . . 
 
 Interest paid during month 
 
 Certificates of corporations and 
 other organizations herewith 
 attached, representing coupons 
 amounting to $200,000 
 
 Certificates of individuals claiming 
 exemptions herewith, for interest 
 amounting to 250,000 
 
 $3,300 cash, representing amount 
 withheld for persons not claim- 
 ing exemptions on interest 
 amounting to 330,000 
 
 Certificates of Collecting Banks 
 withholding tax on interest 
 amounting to 10,000 
 
 Total as above $790,000 
 
 $40,000,000 
 
 800,000 
 
 50.000 
 
 850,000 
 
 60.000 
 
 $790,000 
 
 8 
 
It will be seen that under the mortgages with the 
 covenant, the manner of paying the interest will not be 
 changed from the present methods and the records kept 
 by the paying agent will not require alteration, but the 
 paying agents will be obliged to take as good care of the 
 certificates as they do of the coupons, and also see that 
 the amounts stated on the certificates agree with the 
 amount of coupons presented for payment. The banks 
 handling these coupons will also proceed as formerly, 
 except to see that certificates accompany the coupons. 
 
 In the mortgages which do not contain the covenant, 
 the proceedings are exactly the same as described above, 
 except with respect to individuals not claiming exemp- 
 tions, in which instances the paying agent will of course 
 deduct the tax and pay the bondholder only ninety- 
 nine cents on the dollar. In such cases the paying 
 agents can open “Income Tax Accounts” for each 
 issue, on their coupon ledger, and credit thereto the 
 amounts so deducted. These accounts can be verified 
 from time to time by running up the amounts shown 
 on the certificates of taxable persons. 
 
 As a majority of the mortgages contain the covenant, 
 and as under the law no tax is held out on the obliga- 
 tions of the United States or its possessions, or the 
 obligations of any State or political subdivision thereof, 
 and as doubtless many of the bonds which do not con- 
 tain the covenant are held by corporations, non-resident 
 foreigners, and individuals with small incomes, it will 
 readily be seen that under the plan adopted, while only 
 a very small amount of coupons will actually be paid at 
 ninety-nine cents on the dollar, yet the Government ob- 
 tains the full tax to which it is entitled, and in such a 
 manner that it is easy to verify the collection of the total 
 tax on each issue of bonds, of each corporation. While 
 this condition will last for a considerable period, the 
 amount of coupons to be paid at ninety-nine cents will 
 gradually increase by reason of the provision of the law 
 casting doubt on the validity of these tax-free covenants, 
 and corporate bonds hereafter issued will in many cases 
 not contain the covenant; such bonds will naturally be 
 
 9 
 
treated the same as is above indicated for existing bonds 
 not containing the covenant. 
 
 Of course any foreign paying agents of United States 
 corporations will be obliged to proceed in exactly the 
 same manner as if they were located in the United 
 States. 
 
 Under the regulations the debtor corporations are 
 obliged to notify the Collector of Internal Revenue of 
 their districts who its paying agents are. The object 
 of this provision is doubtless so that the Government 
 can know where to look for the collection of the tax 
 upon the interest of each corporation. 
 
 Each debtor corporation should also immediately 
 instruct its paying agent of its wishes regarding the 
 tax covenant, if contained in its mortgage, and supply 
 the agents with the tax money where a taxable person’s 
 tax is to be assumed. 
 
 FOREIGN INCOME. 
 
 It will be observed that the tax on income from for- 
 eign securities is collected in a different manner than 
 the tax on interest of domestic corporations, even 
 though the foreign corporation has a paying agent in the 
 United States. This is apparently necessary because 
 foreign coupons deposited in the United States for col- 
 lection might go directly to the foreign country for pay- 
 ment, instead of to the paying agent in the United 
 States, and consequently the Government would lose 
 taxes if the paying agent was selected as the source 
 for this class of income. The Treasury Department has 
 therefore apparently for this reason designated as the 
 one to withhold the tax the first person, or bank, pur- 
 chasing or accepting for collection such coupons, checks 
 or bills of exchange, and such person or bank must pro- 
 cure a license. Inasmuch as no tax can be held out 
 against corporations and non-resident foreigners, and as 
 individuals also have a lawful right to claim exemptions 
 on income of this character as well as domestic interest, 
 the regulations of the Treasury Department provide that 
 these exemptions may be claimed by certificates, the 
 same as in the case of interest of domestic corporations, 
 
 10 
 
except that the person or bank first purchasing or receiv- 
 ing these coupons, etc., shall retain the certificates, while 
 the coupons, checks or bills of exchange themselves bear 
 the evidence to subsequent holders of whether they are 
 exempt from taxation or the tax has been withheld. 
 
 Foreign corporations having a tax guarantee clause 
 in their mortgage will doubtless raise the question of 
 the manner in which under this plan they can carry out 
 their guarantee. This can be done in the following way : 
 If the coupons presented to the foreign corporation, or 
 its paying agent in the United States, bear the endorse- 
 ment “Exemption claimed,” the corporation of course 
 simply pays the face value of the coupon. If, however, 
 the coupon bears the endorsement “Income Tax With- 
 held,” it will immediately become apparent that the 
 corporation must pay the coupon at one hundred and 
 one per cent., — one hundred per cent, for the coupon 
 and one per cent, for the tax which is withheld by the 
 bank accepting the coupon for collection from the 
 original owner. If coupons are purchased instead of 
 being taken for collection, this one per cent, will nat- 
 urally have to be taken into consideration in the price 
 when passing from one dealer to another. 
 
 EMERGENCY PROVISION. 
 
 The regulations contain an emergency provision for 
 coupons due November 1st which may be in transit at 
 this time without Ownership Certificates. This permits 
 the bank presenting such coupons to the paying agent 
 to file a temporary certificate pending the receipt of the 
 regular Ownership Certificate and thereby avoiding the 
 necessity of returning the coupons to the owner for the 
 regular certificate, which in many cases might work 
 hardship on the owner. This provision permits the 
 return of any tax improperly withheld, upon the receipt 
 of the regular certificate. Debtor corporations with the 
 tax covenant in their mortgages should explicitly advise 
 their paying agents of their wishes with respect to this 
 feature in connection with emergency certificate. 
 
 11