Chairman RANGEL. Thank you very much.

Now, James Halpern of Baker & Hostetler here in Washington.

STATEMENT OF JAMES S. HALPERN, TAX PARTNER, BAKER & HOSTETLER, WASHINGTON, DC

Mr. HALPERN. Thank you, Mr. Chairman.

Being on this panel of experts and being the last speaker before lunch, I am reminded of the plight of the Chatauqua speaker who went into a town and told the audience he could speak about anything and asked them what they wanted him to speak about. A fellow in back put his hand up and said: "Speak about 2 minutes and then sit down." [Laughter.]

So with that in mind, I will relate my experience in representing some trade associations who have been approached in numerous cases_by_professors and other experts who have proposals for research. The associations come to my firm and ask what the tax benefits would be. They ask whether a credit is available to their members for research paid for by the association.

We have looked at the law and said that that would be a nice idea, the Internal Revenue Service might allow it, there are joint venture provisions in the present code, but we do not see any certainty to it. With that in mind and starting with the assumption that the credit is a good thing, we would simply recommend that if it is extended and the provisions are reexamined, Congress perhaps make it clear that the credit is available for a passthrough to association members.

There are certain issues of policy on the profit-making activities of exempt activities that would have to be looked at. We would be willing to cooperate with the committee or its staff in looking at those activities.

Thank you for the opportunity to testify.

[The prepared statement follows:]

STATEMENT OF JAMES S. HALPERN, TAX Partner, BAKER & HOSTETLER

INTRODUCTION

Mr name is James S. Halpern. I am a member of the New York and District of Columbia bars. I am a partner in the law firm of Baker & Hostetler. Before joining Baker & Hostetler in October of 1983, I served for three years as Principal Technical Advisor to the Associate Chief Counsel (Technical) of the Internal Revenue Service. Prior to that, I both practiced law and taught as a law professor.

My testimony today is restricted to two issues of interest to the Subcommittee: (1) whether present law rules on the availability of the use of the credit have been effective to accomplish Congressional intent, and (2) whether any statutory or administrative changes should be made in the event the credit is continued.

BACKGROUND

In enacting section 44F of the Internal Revenue Code of 1954, Congress intended to stimulate private sector expenditures for research and experimentation. The House Ways and Means Committee Report on section 44F indicates that over the twelve-year period from 1968 to 1979 research expenditures as a percentage of real gross national product (GNP) declined from 2.01% to approximately 1.58%. The tax credit for qualified research was seen as a way to increase expenditures for research.1

'H. Rep. No 97-201, 97th Cong., 1st sess. (1981), p. 111; S. Rep. No. 97-144, 97th Cong., 1st sess. (1981), pp. 76, 77.

My experience is that an increasing amount of interest in research is being focused at the trade association level.2 Such associations can serve either as an independent impetus for research or as a coordinating body for joint efforts by some or all members. This is particularly true with regard to basic research, which may be of little competitive advantage to any particular member of the industry, but may be of great advantage to the industry as a whole.

RECOMMENDATION

I recommend that the statute be amended to accommodate joint research carried out through trade associations, with the credit benefit of such research passing through to members (and possibly nonmembers) who fund such research.

DISCUSSION

Such a change would make the statute more efficient and is consistent with (1) the legislative history of section 44F and (2) administrative policy in a related area, section 174, which deals with a deduction for research and experimental expendi

tures.

With regard to the present provisions of section 44F and its legislative history, it is clear that Congress contempleted a certain amount of joint venturing in conducting qualified research.

The House Ways and Means Committee Report on section 44F states: "[T]t is intended that the Treasury will issue regulations, for credit purposes only, which will allow the credit in the case of research joint ventures by taxpayers who otherwise satisfy the [trade or business] test and who are entitled to the research results."s Section 44F(f)(2) states that Treasury regulations shall be issued providing for the pass-through of the credit in the case of estates, trusts, and partnerships. Proposed Treasury regulations (viz., section 1.44F-2(a)(4) and -7(a) (2), (3)) have been issued dealing with these entities. It is interesting to note that proposed regulations section 1.44F-2(a)(4) (ii) contemplates research by a partnership that is carried out not on behalf of the partnership, but on behalf of its members (so long as each member is entitled to the research results and would have been entitled to the credit has the member conducted the research itself). Such research expenditures are treated as paid or incurred directly by the member. Id. Thus, the partnership or joint venture is treated as a true conduit.

In Rev. Rul. 73–324, 1973–2 C.B. 72, a member of a trade association was allowed a deduction under section 174 for payments made to the association to carry out research. The Service issued that ruling even though section 174 does not provide for any pass-through. Because section 174 contains no pass-through provision, the Service may have felt compelled to create one. It is unclear how the Service would rule under the same set of facts contained within Rev. Rul. 73-324 if the trade association member were to request a pass-through for section 44F purposes (section 44F had not been enacted when the ruling was issued). On the one hand, the Service may allow the pass-through to be consistent with section 174 treatment. On the other hand, the Service may not allow the pass-through, arguing that Congress explicitly provided for pass-throughs when it enacted section 44F and it did not include trade associations and their members. Therefore, if Congress is willing to make the credit available for expenditures carried out through trade associations, it ought to make this clear by amending the statute to so provide.

I believe a pass-through of the credit to trade association members is in keeping with the legislative history of section 44F, the statutory and regulatory provisions, and the administration of related provisions under section 174.

Thus, I recommend that section 44F be amended to include language along the following lines:

"The Secretary shall issue regulations that allow the qualified research expenditures of a business league described in section 501(c)(6) to be passed through to its members."

My proposal, if adopted, would encourage the extensive involvement of trade associations in funding research. Undoubtedly, certain proprietary right (e.g., patents) would result from such research. If ownership of such proprietary rights remains at the association level, questions with regard to licensing income and other effects on

2 The term trade association is in this testimony used to refer to a business league or other entity promoting the common business interests of a group and exempt from tax under section 501(c)(6) of the Code.

3 H. Rep., id., at p. 112.

the association's exempt purpose will arise. Perhaps an efficient policy for encouraging qualified research through the use of trade associations may collide with other policies that currently restrict the activities of tax-exempt entities. An examination should be undertaken of the compatibility of policies for tax-exemption with policies for encouraging research and, if such policies are found incompatible, Congress should address the question of which should prevail as better serving the public interest.

I would be glad to cooperate with members or staff of this Subcommittee in exploring those areas that need examination and, if necessary, in drafting appropriate statutory language to carry out the objectives sought to be accomplished.

CLOSING

I would like to thank the Subcommittee for the opportunity to testify before it today.

Chairman RANGEL. Thank you.

The trade association's objectives, could that be met through basic research done by universities if they could be earmarked?

Mr. HALPERN. Some of it could, but they are looking to attract members' contributions for more than just a deduction for their dues to the trade association, they would like a passthrough of any tax benefits that would occur for the members themselves when they undertook the research.

Chairman RANGEL. Say that again?

Mr. HALPERN. They are looking to pass through to the members the kind of tax benefits, such as the credit, which would be enjoyed by the members.

Chairman RANGEL. The business association members would join in with this research firm and be able to get the tax credit for their membership in the firm that is doing the research and development?

Mr. HALPERN. In a sense. The one or two cases that I have seen, the association has been approached with a research proposal and asked for funding. The members have been willing to fund it and have asked whether they would be entitled to a credit for putting money through the association jointly to do the research, on the understanding that had they directly and without the association in the way funded the research they would have been entitled to the credit.

Chairman RANGEL. And the association would then turn the research over to the member firms and companies?

Mr. HALPERN. Yes.

Chairman RANGEL. Boy, the imagination of those of you that are out there practicing law. It is very interesting.

Let me thank all of you for your testimony. And again, we hope you stay in close touch with the committee. We certainly will be reaching out for any new ideas that may come up in asking for your advice.

Our record will remain open until September 17, in case those of you who have had the opportunity to listen to industry representatives, or if after reviewing the record, feel that there is some additional information you would want to present to the committee. Even if the record is closed, we would still welcome the opportunity for you to bring your views forward.

Thank you so much.