reports that 158 additional cases have been considered-that is, more cases have been considered by the Bureau of Internal Revenue in this recent eight months' period than were considered in the preceding eight years. These new cases appear to be fairly well divided between operating companies and mere holding and investment companies. It is extremely difficult for the Bureau of Internal Revenue effectively to enforce the provisions of section 220. The principal difficulty arises from the fact that section 220 is necessarily vague in its terms. The test of its application (except in cases of mere holding and investment companies) is whether the accumulations of income are beyond the reasonable needs of the business. The intent of the statute on this point is clear, but the difficulty of determining the facts in most cases is extremely great. The needs of a business depend largely on the intention of its owners in regard to its development. In deciding such cases long after the event, the commissioner is called upon to substitute his business judgment as to the prospective needs of an enterprise at a given date for the current judgment of those responsible for the conduct of the business. In some industries, such as banking, the reasonable. needs of the business appear to be limited only by the imagination of the directors. A more specific definition of the test to be applied which will work out satisfactorily in all cases seems well-nigh impossible. Arbitrary rules setting up certain required percentages of distribution in relation to total income or total surplus are obviously unsatisfactory because of the fact that no two corporations are similarly situated. The problem is very much more difficult than determination of reasonable salaries, reasonable allowances for depreciation, and similar problems. The second difficulty is the requirement that the Bureau of Internal Revenue find in all cases (except in those involving mere holding and investment companies) the existence of "a purpose to " evade surtax on the part of the taxpayer. This not only involves the determination of motive or purpose which is particularly difficult in the case of a corporation since corporate action is determined by the board of directors or the principal stockholders or some of them, but involves a consideration of the various purposes which may have influenced the judgment of the various individuals who determined the action of the corporation. A third difficulty arises in determining what constitutes “a mere holding or investment company." An actual case considered by the Bureau of Internal Revenue will illustrate this difficulty. A corporation was organized in 1916 with an authorized capital stock of $100,000; X transferred to the company stocks, bonds, and other securities worth approximately $3,000,000 in exchange for its capital stock. He gave most of this stock to his wife and children. In the years 1919 to 1921, inclusive, this company had profits of $820,183.02 and the cash dividends declared were but $50,000. The company held nothing but stocks and bonds of various corporations and municipal and Government bonds. It claimed that it was necessary for it to invest additional funds in certain companies where its interest was large and made only normal charges in its investments. The Solicitor of Internal Revenue held that it was not "a mere holding company" and that its gains and profits had not been accu mulated beyond the reasonable needs of the business in any of the years in question. A fourth difficulty in applying section 220 arises from the fact that the Bureau of Internal Revenue does not automatically receive the necessary facts to determine whether or not the section is applicable. The income-tax returns do not show the nature of the investments held by the company, nor do they show what the reasonable needs of the business are considered to be by the corporation management. This difficulty could be remedied to some extent by the use of a special questionnaire to be sent to taxpayers, but essentially every case is one requiring special investigation. There is an entire lack of published rulings and decisions in regard to the application and interpretation of section 220. No cases on this subject have reached trial before the courts or the Board of Tax Appeals. Up to October 1, 1926, only two cases involving the question had been docketed with the Board of Tax Appeals and but three additional cases have since been docketed. It is thus apparent that the administration of section 220 is an inherently difficult problem, and there appears to be no method by which these inherent difficulties can be satisfactorily overcome. The present section imposes an additional income tax of 50 per cent on the corporations coming within its provisions. The maximum surtax on individual incomes is but 20 per cent, so that the maximum amount of additional revenue which the Government would have received if reasonable distributions had been made would be a 20 per cent surtax on the distributions to stockholders. The maximum individual normal and surtax rates combined aggregate 25 per cent. The corporation tax is 1312 per cent. The loss of revenue resulting from the receipt and accumulation of income by a corporation rather than by an individual can not, therefore, exceed 1112 per cent. The penalty on the corporation for unreasonable accumulation of income is thus out of proportion to the loss of revenue to the Government and takes on much of the aspect of a penalty rather than a tax provision. The lack of proportion between the penalty and the loss of revenue may as a practical matter lead to nonenforcement of the provision, and this is an additional objection to the retention of section 220 in its present form. In recent years the opportunities for evasion of taxes through the use of corporations have been greatly diminished, first by reason of the reduction in surtax rates, and second, by the prevention of the opportunity of realizing the income unreasonably accumulated at a low cost in taxes. When the corporation income-tax rate was but 10 per cent and the maximum individual surtax rate was 65 per cent, there was a much greater inducement to make unreasonable accumulations of profits than there now is when the corporation income-tax rate is 1312 per cent and the maximum surtax rate is but 20 per cent. Furthermore, under some of the earlier acts the stock of a corporation could be given to a near relative and resold without tax, except on the difference between the value on the date of the gift and the amount realized on the sale, so that it was possible in effect to take over the unreasonable accumulated profits without substantial tax liability. Under the present act when property acquired by gift is sold the taxable income is measured by the difference between the cost of the stock to the donor, and its selling price and the accumu lated profits when realized by such a sale have been subjected to the corporation income tax of 1312 per cent, and in large cases to a tax at 122 per cent on the capital gain, a total tax of 26 per cent, which exceeds the maximum normal and surtax rates on individual incomes. By reason of these changes in the statute there is a tendency. on the part of some who in the past have formed personal corporations in order to save taxes to disincorporate for the same purpose, particularly where as in New York the State tax rate on corporate income is greater than on individual income. These changes in the relative burden of taxation on corporations and individuals have greatly reduced the seriousness of the problem which section 220 was designed to solve. It may be helpful to consider the experience of Great Britain in connection with the subject of supertax avoidance by incorporation. The British finance act of 1922 included a provision somewhat similar to section 220 of the Revenue Act of 1918. It provided that any company organized after April 5, 1924, which was under the control of five persons or less and did not have more than 50 stockholders, and which did not make a reasonable distribution of profits, would lay its stockholders open to the imposition of the supertax as if such proper distribution had been made. This provision applied only to what is classified in Great Britain as "a private company." Mr. Mitchell B. Carroll, chief tax section, division of commercial laws, in an article entitled "British finance act of 1927 makes radical changes in the tax system," published in Commerce Reports of August 29, 1927, said: The provision in the 1922 act proved ineffective because of the opportunities which it offered for circumvention. Only 550 of the 40,000 companies subject to the 1922 act were subject to investigation during the last four years-an average of 135 a year. The inland revenue claimed surtax in 250 cases, and of that number 128 were appealed to the special commissioners. That body decided in favor of the taxpayer in 60 cases and against the taxpayer, in whole or in part, in 69 cases. Only 11 cases were carried to the board of referees, which decided 5 cases in favor of and 6 against the taxpayer. The finance act of 1927 considerably broadens the scope of the act of 1922 and provides for a procedure of investigating the avoidance of supertax through incorporation, which is expected to be considerably more effective than formerly. It can thus be seen that although Great Britain has considered twice as many cases on this point under its 1922 act as we have under all our acts, and has assessed and collected the tax in about 198 cases, as compared with a negligible number assessed by our Bureau of Internal Revenue, nevertheless Great Britain considers the provisions of the 1922 act unsatisfactory, and has taken means to make such provision more readily applicable in the present finance act. Unfortunately, on account of the different classification of companies in England, and their different system of tax administration, investigation indicates that it is not possible for us to adopt the British system. The British system can be summed up as follows: 1. The procedure is to tax stockholders as if the profits had been distributed, a procedure formerly embodied in our law but abandoned on constitutional grounds, which, of course, do not arise in Great Britain. 2. The provisions are restricted to a special class of companies, companies in which the public is interested being expressly excluded.. 3. Notice of a proposed assessment must be given currently and the issue is then presented promptly to an independent board of referees, whose decision on the question whether there is a prima faciecase under the statute is conclusive. The problem in Great Britain is somewhat different from our problem. There the rate of tax on corporations and the normal rate on individuals are the same. Their surtaxes are higher than ours. Their capital gains are not taxed at all. The problem is, therefore, a much more serious one for Great Britain than it is for the United States. The British plan has the desirable features of reasonableness of tax or penalty, expeditious determination of liability, and limited application to restricted and well-defined classes of companies, but there seems to be no way in which the British procedure could beadapted to meet our problem without departure from our present general scheme of administration. In view of the inherent difficulty in enforcing section 220, the unde-sirability of having provisions in the statute which are not generally enforcible nor enforced and the decided change in the importance of the problem because of the reductions in tax rates and the special provisions of the statutes preventing realization on the unreasonably accumulated profits without payment of adequate taxes, it has been thought desirable to find some plan which would automatically encourage reasonable distributions on the part of corporations and discourage unreasonable accumulations and make it possible to repeal section 220. The principal methods of accomplishing the desired result which have been considered are as follows: Undivided profits tax.-One method of automatically accomplishing the desired result is the so-called " undivided profits tax." While this method has long been known and considered, it has been advocated in such various forms that a complete discussion can not beattempted here. The general basis of such a tax is the imposition of a tax on the undistributed earnings of a corporation in addition to the usual income tax. Such a method may or may not contemplate the exemption from further tax of such earnings when ultimately distributed. The most obvious objection to such a tax is the burden which it places on legitimate and proper business expansion. As a business expands not only does its plant and property increase but a larger working capital is required and it is desirable that reasonable accumulations of profits necessary for the expansion and stability of corporations should not be unduly burdened. A tax placed only upon the unnecessary accumulation of capital instead of upon the total accumulation involves many of the difficulties inherent in section 220 and is. certainly an impracticable solution of the problem. It is believed that a tax on the total accumulation of profits by corporations is not desirable, because in many cases it might cause the making of unwise distributions and prevent the accumulation of a reasonable and proper surplus. Taxation of dividends to the recipient.-Another method, which would prevent any large amount of tax evasion by incorporation,. would be to allow the corporation to deduct from taxable income the full amount of dividends paid during the taxable year in cash or in property and to tax such dividends to the stockholders at the full normal and surtax rates. This would, of course, be a fundamental change in the structure of our present Revenue Act and should not be made without careful study. There might be noted as objections to such a method: 1. It would decrease the total revenue because much income now subject to the corporation income tax would be distributed to individuals paying a low rate of tax or no tax at all. Such a plan, therefore, requires a general readjustment of tax rates. 2. It would probably increase the difficulties of collection, since there would be many small sums to be collected from the many stockholders instead of large sums from the corporations. 3. It is open to the same general objection as an undistributed earnings tax since it might encourage unwise distributions. There can be claimed as advantages for such a method: It would be an automatic check on evasion of surtaxes by incorporation as there would be a tax, otherwise not payable, remaining on the income which the corporation did not distribute. It would go far to make possible an important simplification of the tax law, for if dividends were taxed on the same basis as other income means might be found whereby the present normal and surtax rates could be combined into one graduated scale of rates for individuals. Partial deduction for corporations on account of cash dividends.A third method, and the one which is recommended, is to allow the corporation a deduction in computing net income equal to, say, 20 per cent of the excess of dividends paid over dividends received, the deduction in no case to be more than, say, 25 per cent of the corporation's taxable net income before such deduction. In this computation no account should be taken of stock dividends. This method appears to be of such a nature that it can readily be applied to the present structure of our revenue act. An illustration will show how this plan would operate: If a corporation having a net income of $1,000,000 distributes cash dividends of $500,000, it will get a deduction of 20 per cent of $500,000, or $100.000. The taxable net income will then be $900,000 instead of $1,000,000, and the tax at 132 per cent will be $121,500 instead of $135,000, a saving in corporate tax of $13,500. The effect upon the corporation income-tax rate will, of course, depend upon the proportion of income distributed as dividends. Based on the present corporation income-tax rate of 132 per cent, this would result as follows: If total net income is distributed, the tax would be equivalent to that produced by a present tax rate of- If one-half of the net income is distributed, the tax would be equivalent Per cent 10.80 12. 15 13. 50 This method would afford a means of relief to the small corporations owned by individuals with small incomes, which at present bear a burden which is very heavy as compared to the tax burden on similar enterprises which are unincorporated. The stockholders of |