ered highly compensated for purposes of the coverage and nondiscrimination requirements applicable to qualified plans generally.) For this purpose, employees who hold 10 percent or less (determined with attribution rules) of the employer's stock (outside of the ESOP) are not considered shareholders.

Withdrawal of contributions.-If the plan provides, the Act permits funds contributed by the employer to be withdrawn from an investment credit ESOP (1) to refund employer contributions which are not matched by employee contributions within the period specified, or (2) to permit the employer to recover from the ESOP any portion of the employer's contribution which is recaptured from the employer under the investment credit rules (for example, where the property for which the credit is claimed is disposed of prematurely). The Act provides that the withdrawal of employer contributions made under the one-half percent credit rules because they are not matched by employee contributions, or a recovery of employer contributions under the recapture rules, will not cause the plan to be considered as other than for the exclusive benefit of employees and that employee rights to employer-derived benefits under the plan will not be considered forfeitable merely because employer contributions of investment. credit may be withdrawn under the matching or recapture rules. The Act does not permit an employer to recover recaptured investment credit unless the employer contributions for each year are separately accounted for (all contributions made before enactment of the Act can be aggregated for this purpose).

Under the Act, employee funds contributed to an investment credit ESOP are subject to employee withdrawal unless they are matched by employer contributions under the one-half percent credit rules. For example, if matching employer or employee contributions cannot be made because of the overall limitations on benefits and contributions (sec. 415 of the Code), the unmatched employee contributions would be refunded to the employee (unless he instructs the plan to the contrary).

(b) Employee Stock Ownership Plan Regulations

The Act reaffirms Congressional intent with respect to employee stock ownership plans and expresses concern that administrative rules and regulations may frustrate Congressional intent. In this connection, it has come to the attention of the Congress that proposed regulations issued by both the Department of the Treasury and the Department of Labor on July 30, 1976, may make it virtually impossible for ESOPS, and especially leveraged ESOPs, to be established and function effectively. The following areas are of specific concern to the Congress.

(1) Independent third party. The proposed rules would prohibit loans (or loan guarantees) by fiduciaries to employee stock ownership plans unless the loans are arranged and approved by an independent third party. These rules would, for example, prevent a bank which serves as trustee for an ESOP from making a loan to the plan and would prevent the employer-fiduciary who established the plan from providing a loan guarantee.

In view of other rules presently in effect, which require that the interest rate for any such loan be reasonable, that the loan be primarily

for the benefit of participants or their beneficiaries, and that the only collateral the plan can give the lender is the employer's stock purchased with the loan proceeds, the requirement of an independent third party is unduly burdensome. Consequently, the Congress believes that the regulations should deal directly with possible abuses which may occur in the administration of plans rather than attempting to require a plan to incur the burden of dealing through an independent third party. Similarly, the Congress believes that an independent third party should not be required to arrange and approve a sale of stock between an employer (or shareholder of the employer) and an ESOP. The Congress has not considered whether the principles applicable to ESOPs in connection with loans to the plan or sales of employer stock should apply in the case of other exemptions from the prohibited transaction rules and, accordingly, no inference should be drawn regarding those other exemptions.

(2) Put option.-The proposed regulations would require that an employer provide each employee who receives stock from a leveraged ESOP or an investment credit ESOP with a 2-year "put option" if the stock is not listed on an exchange.

Although the Congress agrees that a market should be provided for employer stock distributed by an ESOP to an employee, the Congress believes that a put option for a period considerably shorter than two years will properly protect employees and that a put under which the employer must pay for tendered stock over too short a period would effectively deny the employer the benefits of capital formation the Congress sought to provide under an ESOP. On the contrary, the Congress believes that the payment by the employer could be made in substantially equal installments over a reasonable period, taking into account the need to protect the interests of employees and the need of the employer for capital.

(3) Stock purchased with loan proceeds. Under the proposed regulations, if an ESOP holds employer stock which it purchased with the proceeds of a loan, the stock is to be placed in a suspense account from which it is to be released under a formula. The formula provided by the proposed regulations, however, is not in accordance with the common business practice under which the stock is released from the account as loan principal is amortized.

The Congress believes that the regulations should allow the stock to be released as the loan principal is repaid if (a) the principal is amortized over a reasonable period (taking into account the facts and circumstances, including the interests of plan participants and the employer's need for capital), and (b) the employees are adequately informed regarding their rights to employer stock held by the plan. (4) Allocation of stock.-Under the proposed regulations, employer stock acquired by an ESOP with loan proceeds must be allocated to plan participants as it is released from the suspense account discussed in (3) above. The Congress believes that the regulations should permit the allocation of stock to be made in accordance with formula more similar to that provided for ESOPS in the Trade Act of 1974 (19 U.S.C. § 2373 (f) (4)).

(5) Voting rights.-The proposed regulations would require that employees be permitted to direct the voting of employer stock allo

cated to their accounts under a leveraged ESOP even though other types of employee plans need not provide employees with these rights. (The Tax Reduction Act of 1975 requires that employees be permitted to direct the voting of employer stock allocated to their accounts under an investment credit ESOP but not under other ESOPs.) The Congress believes that the regulations should not distinguish between leveraged ESOPs and other employee plans in this regard.

(6) Dividend restrictions.-Under the proposed regulations, employer stock held by an ESOP must have unrestricted dividend rights. However dividend restrictions are commonly required in connection with loans. Consequently, the Congress believes that such restrictions should be permitted if they are required in connection with a loan o the ESOP for the purchase of employer securities (but only if the restrictions terminate when the loan is repaid) or if they apply also to a significant portion of the employer stock not held by the ESOP.

(7) Right of first refusal. The proposed regulations prohibit a leveraged ESOP from acquiring, with the proceeds of a loan, employer stock subject to a right of first refusal. Because the shareholders of many corporations (especially smaller businesses) believe that a right of first refusal is necessary to protect their interests, the Congress believes that the prohibition will have a chilling effect upon the establishment of ESOPs and that a right of first refusal should not be proscribed.

(8) Treatment of sale as redemption. Under the proposed regulations, the sale of stock by a corporate shareholder to the corporation's ESOP could, depending upon the facts and circumstances, be treated as a redemption of the stock by the corporation. If the sale is treated as a redemption, the proceeds of the sale could be considered dividend income rather than capital gain. The Congress believes that if such a rule is authorized and proper, its application should not be restricted to ESOPS and that it should be applied only where the stock sold by the shareholder inures to his benefit (or the benefit of related parties) under the plan.

(9) Nonvoting common stock, etc.—The proposed regulations impose special rules on ESOPs which limit the extent to which the plan can acquire employer securities, other than voting common stock with unrestricted dividend rights, with the proceeds of a loan. (The Tax Reduction Act of 1975 does not allow the additional investment credit for nonvoting employer stock.) The Congress believes that the usual rules applicable to employee plans properly protect the interests of plan participants and that these special rules are not needed.

(10) Prepayment penalty.-The proposed regulations specifically prohibit any loan made to an ESOP from containing a provision for a prepayment penalty. The Congress believes that the question of such penalties should be a matter of negotiation between the ESOP and the lender and that prepayment penalties should not be prohibited in all cases. (They should not be allowed of course if, for example, payment of a penalty would be imprudent.)

(11) No calls or other options. The proposed regulations prohibit stock acquired with an ESOP loan from being subject to any calls or options (other than the put option described in (2) above). There is no provision for restrictions which may be required by State or Federal

law. The Congress believes that in the limited situation where restrictions are imposed by law, stock in an ESOP should be permitted to have restrictions necessary to comply with the law.

(12) Comparability.-The proposed regulations do not permit an ESOP and another plan to be considered a single plan for purposes of determining whether the plans meet the anti-discrimination requirements of the tax law. Although the Congress agrees that an ESOP and another type of plan should not be considered a single plan for this purpose, the Congress believes that this rule should not be applied to disqualify a plan already in existence and that two or more ESOPS can be considered as a single plan in testing the coverage and contributions or benefits under the plans.

As stated in the Report of the Senate Finance Committee on the bill, an ESOP is designed to "build equity ownership of shares in the employer corporation into its employees substantially in proportion to their relative incomes." (S. Rept. No. 94-938, p. 180.) The Congress understands that, under the proposed regulations, an ESOP could be integrated with the social security system so that employer stock would not be allocated to employees substantially in proportion to their compensation. The Congress believes that social security integration is not consistent with the purposes of an ESOP. The Congress believes, however, that a prohibition on integration should not apply to ESOPs which were integrated at the time the Act was enacted.

(13) Inferences.-Although the Congress has commented on the merits of the proposed regulations, these comments should not be taken as inferring approval or disapproval of the provisions not commented upon.

(c) Study of Expanded Stock Ownership

The Act changes the name of the existing Joint Pension Task Force to the Joint Pension, Profit-sharing and Employee Stock Ownership Plan Task Force, and provides that the Task Force is to study employee stock ownership plans. The Task Force, which may consult others who have information concerning employee stock ownership plans, is to report its findings to the Committee on Ways and Means and the Committee on Education and Labor of the House and the Committee on Finance and the Committee on Labor and Public Welfare of the Senate by March 31, 1978.

Effective date

The additional one-half percent investment tax credit applies for taxable years beginning after December 31, 1976. The investment credit "flow through" provisions apply for taxable years beginning after December 31, 1975. The special limitation on contributions for ESOPS applies for taxable years beginning after December 31, 1975. The other provisions generally apply for taxable years beginning after December 31, 1974.

Revenue effect

The general provisions for the one and one-half percent investment credit ESOPs are expected to decrease revenue by $107 million in fiscal 1977, $257 million in fiscal 1978, $303 million in fiscal 1979, $332

million in fiscal 1980, $189 million in fiscal 1981. The regulations and study provisions have no effect on revenue.

4. Investment Credit in the Case of Movies and Television Films (sec. 804 of the Act and sec. 48 of the Code)

Prior law

Under the tax law, taxpayers are entitled to receive an investment credit for tangible personal property (i.e., section 38 property) which is placed in service by the taxpayer. In order to receive the full credit, the property placed in service by the taxpayer must have a useful life of at least 7 years. If the property has a useful life of at least 5 years (but less than 7 years) the taxpayer is entitled to two-thirds of the full credit. If the property has a useful life of at least 3 years (but less than 5 years) the taxpayer is entitled to a one-third credit. In addition, there cannot be any predominant foreign use of the property during any taxable year, or the property will cease to qualify as section 38 property.

Prior to 1971, it was not clear whether (and if so, under what conditions) the investment credit was available for movie or television films. However, a court case had held that movie films were tangible personal property eligible for the investment credit. During the legislative consideration of the Revenue Act of 1971, it was made clear that motion pictures and television films are to be treated as tangible personal property eligible for the investment credit (i.e., section 38 property). However, this issue was still being litigated for years prior to 1971, and there were still a number of other unsettled issues, such as how to determine the useful life of a film, the basis on which the credit is to be computed, and how to determine whether there has been a predominant foreign use of the film.

Reasons for change

Due to the uncertainties of prior law with respect to the questions of useful life and predominant foreign use, it was often difficult to determine whether a film was entitled to a full credit, a partial onethird or two-thirds credit, or possibly no credit. Congress felt that it was desirable to clarify these issues, in order to avoid costly litigation with respect to the past, and to allow accurate investment planning for the movie industry in future years.

To achieve the objective set out above, the Act, for past years, allows taxpayers to determine their investment credit on a film-by-film basis in accordance with certain statutory rules prescribed under the Act with respect to useful life and predominant foreign use, or to elect to take a 40-percent compromise credit for all their films, regardless of the actual useful life or foreign use of any particular film. The Congress believes that this 40-percent figure represents a fair compromise between the litigating position of the Internal Revenue Service, on the one hand, and members of the industry, on the other hand.

In addition, since the major purpose of the investment credit is to create jobs in the United States, the Act provides that for the future the amount of the investment credit in the case of movie films is to depend on the place of production of the film (i.e., United States or foreign), rather than on the place where revenues are received for showing the film. Thus, the foreign use test will not apply to movie