STATEMENT OF THE MANAGERS ON THE PART OF THE HOUSE

The managers on the part of the House at the conference on the disagreeing votes of the two Houses on the amendments of the Senate to the joint resolution (H. J. Res. 596) entitled "Joint resolution making an additional appropriation for relief purposes for the fiscal year ending June 30, 1938," submit the following statement in explanation of the effect of the action agreed upon and recommended in the accompanying conference report with respect to each of such amendments, namely:

Amendment No. 1: Strikes out the language, inserted by the Senate, authorizing under the appropriation the prosecution of projects for the production of materials for fertilizer for distribution. under conditions determined by the sponsors of such projects under a State law.

Amendment No. 2: Reports in disagreement the proviso, inserted by the Senate, waiving the requirement of the Emergency Relief Appropriation Act of 1937 as to the distribution of the appropriation made in the joint resolution and apportionment of the same during the remaining months of the present fiscal year.

Amendment No. 3: Accepts the action of the Senate in striking out the proviso inserted by the House with respect to the limitation of the use of the appropriation in the employment of aliens.

MARCH 1, 1938.-Committed to the Committee of the Whole House on the state of the Union and ordered to be printed

Mr. DOUGHTON, from the Committee on Ways and Means, submitted the following

REPORT

[To accompany H. R. 9682]

The Committee on Ways and Means, to whom was referred the bill (H. R. 9682) to provide revenue, equalize taxation, and for other purposes, having had the same under consideration, report it back to the House without amendment and recommend that the bill do pass.

The need for a comprehensive revision of our internal-revenue laws was foreseen at the first session of the Seventy-fifth Congress, as shown by House Resolution 332, adopted at that session, which authorized the study of such a revision by the Committee on Ways and Means or by a subcommittee thereof. A subcommittee on taxation was promptly appointed and was almost continuously in session. from November 4, 1937, to January 14, 1938, on which date they rendered their report to the Committee on Ways and Means. The subcommittee considered the whole field of internal-revenue taxation in the hope of recommending such changes therein as would improve the equity and certainty of existing law, remove hardships, and encourage business activity. The Committee on Ways and Means have carefully considered the recommendations of the subcommittee and have held extensive public hearings in regard thereto. In the course of these hearings, which lasted for 10 days, all persons who requested the right to appear were given an opportunity to do so. Testimony was heard from approximately 115 witnesses. The published record of the hearings contains 1,215 pages of testimony, statements, and exhibits, including 51 briefs. Almost without exception the recommendations of the subcommittee have been found meritorious-only a few have been passed over because they involve matters requiring more extensive study.

The purpose of the bill, as reported, is to improve our existing revenue system, to remove inequities, to equalize the tax burden, and to stimulate business activities, and to accomplish this without reducing the revenue which would be obtained by existing law under present conditions. According to the best information the committee has been able to secure, from the Treasury Department and other sources, it appears reasonably certain that the revenues of the Government will be as great under the bill as under existing law. In any event, it is certain that the changes proposed will tend to stabilize the revenue. Finally, and most important, it is believed that there will be a very substantial stimulation to business by the enactment of the bill into law which will bring into being a well-balanced tax system, improved with respect to certainty and equity.

No change is proposed in the rates of normal tax and surtax on individuals.

As in the case of prior revenue acts, the new bill is not retroactive. The changes in the income tax are effective with respect to taxable years beginning after December 31, 1937. Taxpayers filing income-tax returns this year will not be affected by the changes proposed.

SUMMARY OF PRINCIPAL CHANGES PROPOSED

CORPORATE TAXES

It is proposed to revise completely the present system of taxes imposed upon corporations. Under existing law all corporations, with the exception of a very few special classes, are subjected to a graduated normal tax upon their normal-tax net income and to a graduated surtax upon their undistributed net income. The normal tax rates are graduated from 8 to 15 percent, and the surtax rates from 7 to 27 percent. Limited relief from surtax is given to corporations whose adjusted net income is less than $50,000. In addition to this general rule, corporations which accumulate surplus for the purpose of avoiding the payment of surtaxes by their shareholders are subject to a further surtax of 15 to 25 percent in the ordinary case. Corporations which are closely held and derive the greater part of their income from investment sources (personal holding companies) are subject to a further surtax of 65 to 75 percent. Special methods of taxation are provided in the case of banks, insurance companies, foreign corporations, foreign personal holding companies, and several other special classes.

The committee has given careful study to this system, inaugurated by the Revenue Act of 1936, which system has been subject to extensive criticism. All available statistics were submitted to the committee by the Treasury Department in respect to corporate returns for 1936. A study of these statistics convinced the committee that the surtax on undistributed profits went far toward closing a loophole which had existed in the income-tax law since its inception in 1913. Much tax avoidance had undoubtedly occurred in years prior to 1936, by the avoidance of individual surtaxes through the retention of profits by corporations when such retention was unnecessary.

The opportunity for such tax avoidance in this manner has long been recognized. It may be that this was one of the reasons why, in the Civil War Income Tax Act of 1864, the general rule was to tax corporate profits to the shareholder whether or not such profits were

distributed to him. In the light of court decisions since that time, there is some support for the contention that this system of taxation is unconstitutional for domestic corporations.

In 1913, when the first income-tax law under the sixteenth amendment was enacted, in spite of the fact that the tax rate on corporations was only 1 percent and on individuals only went to a maximum of 7 percent, the opportunity for tax avoidance through the retention of corporate profits was foreseen. This law provided, in effect, that shareholders should include in their income their proportionate share of the net income of the corporation, whether distributed or not, wherever the corporation was formed or availed of to prevent the imposition of surtaxes upon its shareholders. The Revenue Acts of 1916, 1917, and 1918 contained similar provisions. However, these provisions were never used to any extent.

In 1921 the system was changed in the case of corporations formed or availed of to prevent the imposition of surtaxes on their shareholders, so that a tax of 25 percent was levied on the net income of the corporations instead of attempting to tax the shareholder on his portion of the undistributed income of the corporation. This same system, with certain rate and other changes, has been retained in every revenue act since 1921. However, the enforcement of this provision was productive of practically no revenue until 1928, and since that date great difficulty has been experienced by the Bureau of Internal Revenue in its enforcement.

It is true, however, that many of the worst cases of tax avoidance were cured by a special provision contained in Title IA of the Revenue Act of 1934. This provision provides for a surtax on closely held companies the greater part of whose income is derived from investment sources. The provision is designed so that there is no necessity to prove a purpose to avoid surtaxes, and it has been considerably strengthened and improved by the Revenue Act of 1937.

Great Britain has an admirably practical, although far from perfect, system of dealing with this problem. In that country the corporate rate is very high (at the present time 30 percent) but the stockholders when they receive their dividends are allowed what in effect amounts to a tax credit for the taxes paid by the corporation. Great Britain also has a special provision dealing with closely held corporations which unreasonably accumulate surplus. However, it would be extremely difficult for us to adopt the British system at this date.

In 1936, the new method of attacking the problem of obtaining a fair tax on the retained corporate profits was devised as has already been briefly described.

After a careful consideration of this new system the committee has been convinced that a substantial number of cases of hardship had arisen under the Revenue Act of 1936, since the surtax was imposed regardless of the necessity for the retention of earnings by the corporation, or regardless of whether surtaxes on its shareholders were materially diminished by such retention. It also developed that the additional revenue derived from the new system was considerably less than had been estimated.

The principal complaints against the surtax on undistributed profits in the form imposed by the Revenue Act of 1936 may be summarized as follows:

(1) The surtax discourages, in many cases, legitimate business expansion, and, therefore, has an adverse effect on employment.

(2) It puts a penalty on corporations which find it necessary to use current earnings in the payment of debts.

(3) It burdens the small and weak corporations more than the large and financially strong corporations.

(4) It is unfair to corporations with impaired capital which under State law cannot legally declare dividends.

(5) The relief provisions applying to corporations having contracts not to pay dividends or requiring the use of current earnings for the payment of debts are so restrictive as to provide relief only in rare cases, although many other cases equally meritorious receive no relief. The committee has examined these complaints and others and believes that in certain cases they are justified, although in many cases the hardships seem to have been exaggerated. The committee believes that the Revenue Act of 1936 as originally passed by the House, with its relief provisions in regard to corporations in debt and to corporations with impaired capital, would have obviated many of the inequities of existing law. Even under this law, however, it is to be noted that a corporation subject to the normal tax and surtax on undistributed profits provided for in existing law can pay no more than 32.4 percent of its net income in tax even if it distributes none of its income in dividends.

On the basis of the facts, your committee believes that the principle of the undistributed-profits tax is sound and should be retained. However, it is believed that it should be substantially modified. In the first place, the committee believes that it is impractical to put enough relief provisions in existing law to relieve the various kinds of hardship arising thereunder without opening up loopholes of a serious nature. In the second place, the committee believes that small corporations with net incomes of $25,000 or less should not be subject to an undistributed-profits tax. In the third place, in the case of the larger corporations, the committee believes that the tax should not be framed as a penalty surtax on undistributed profits but should be designed on the basis of a flat tax rate with a tax credit which will give reasonable encouragement to the distribution of dividends. Finally, the committee is of the opinion that, in order to protect the revenue, it is necessary to impose a special undistributed-profits tax on closely held corporations, since it is clear that this class of corporations, in many cases, has accumulated unreasonable surpluses with a consequent loss of tax to the Government from the shareholders of such corporations. In view of the above, your committee proposes a complete revision of the present income taxes on corporations, which will now be briefly described. A detailed and technical description of this revision will be found in the latter part of this report.

First. It is proposed to tax corporations with net incomes of $25,000 or less at rates graduated from 12%1⁄2 percent to 16 percent, with no undistributed-profits tax added. This will relieve from undistributed-profits tax about 88 percent of the corporations filing taxable returns. However, this is not serious from a revenue standpoint since this group of corporations only report about 10 percent of the net income reported by all corporations.

Second. It is proposed to tax the group of corporations with net incomes in excess of $25,000 at a flat rate of 20 percent. This rate of tax, 20 percent, imposed by the bill upon corporations which are taxable under the general rule and retain all their earnings, compares