Reasons for change The Federal Highway Beautification Act of 1965 and State highway beautification statutes authorize the government to condemn and purchase privately owned highway billboards. Because of continuing restrictions on where highway billboards may be located, the former owners of condemned billboards (particularly small companies) are prevented from using their condemnation awards to build and situate replacement billboards; these taxpayers have been forced instead to reinvest their awards in other types of property. At the time the Congress enacted the highway beautification legislation it was anticipated that the IRS would permit taxpayers whose billboards were condemned to invest in other types of real property without payment of tax. However, the recent court decisions involving the classification of billboards as tangible personal property for investment credit purposes have put that determination in jeopardy. Thus, in order to permit reinvestments of billboard condemnation proceeds to qualify for tax-free treatment under the involuntary conversion rules in appropriate circumstances, while still not affecting the recent court decisions, Congress decided to allow taxpayers an election to treat outdoor advertising displays as real property. Explanation of provisions Under these provisions, an election is provided for taxpayers to treat outdoor advertising displays as real property. This election, once made, is irrevocable without the permission of the Secretary to change it and applies to all qualifying outdoor advertising displays of the taxpayer. The availability of this election should not be interpreted to prevent owners of outdoor advertising displays who do not make an election from claiming treatment for them as personal property. Outdoor advertising displays do not qualify for the election where the taxpayer has previously treated the property as tangible personal property (by claiming either the investment credit or additional firstyear depreciation). This limitation is necessary to prevent a taxpayer from treating the same property as tangible personal property for purposes of the investment credit and as real property for purposes of the involuntary conversion replacement property and depreciation recapture rules. The term "outdoor advertising display" includes rigidly assembled outdoor signs and displays which are attached to the ground, a building, or other permanent structure for purposes of displaying advertising messages to the public. This term includes highway billboards attached to the ground with wood or metal poles, pipes or beams, with or without concrete footings. The Act also provides that replacement real property will be considered "like kind" property even though a taxpayer's interest in the replacement property is different from the real property interest held in a qualified outdoor advertising display which was involuntarily converted. This is to enable, for example, purchases of replacement property to qualify under section 1033(g) even though a fee simple interest in real estate is acquired to replace in part a billboard owner's leasehold interest in real property on which the billboard was located. Effective date These provisions apply to taxable years beginning after December 31, 1970. It is contemplated that the Secretary will allow taxpayers who have previously made replacements of qualified outdoor advertising displays during closed taxable years a sufficient period of time to make an election for these closed years. Revenue effect It is estimated that this provision will have no appreciable effect on budget receipts. 28. Tax Treatment of Large Cigars (sec. 2128 of the Act and secs. 5701(a), 5702, and 5741 of the Code) Prior law Under prior law (sec. 5701 (a) (2)), the manufacturers excise tax on large cigars (those weighing more than 3 pounds per thousand cigars) was imposed on the basis of a bracket system with the rate of tax dependent on the retail price of the cigar. The brackets were as follows: The retail price of a cigar was defined for Federal tax purposes as "the ordinary retail price of a single cigar in its principal market." The law provided that any State or local tax imposed on cigars as a commodity was to be excluded when determining the ordinary retail price. Reasons for change The prior bracket system was arbitrary in that it produced widely varying effective rates of tax depending on the retail price of the cigar. For cigars intended to retail for 20 cents each or less, the effective rate of tax depended on a combination of the rate of tax for the given bracket in which they fall and the price of the cigar. Thus, in the wide bracket covering cigars intended to retail for over 8 cents and not over 15 cents, the tax rate of $10 per thousand varied from a maximum of 12 percent of the intended retail price (including the tax) for cigars priced at three for 25 cents to a minimum of 6.7 percent for cigars intended to retail for 15 cents each. This 6.7-percent minimum effective rate also applied to cigars at the top of the over 4 cents and not over 6 cents bracket. However, in the over 6 cents and not over 8 cents bracket, the minimum effective rate was 8.8 percent. At the very bottom of the tax scale (namely, in the case of cigars intended to retail for not more than 22 cents each), the tax of $2.50 per thousand imposed an effective rate of 10 percent of the retail price for cigars intended to retail at two for 5 cents. A corollary of the variability of the effective rates of tax was the fact that a shift in the price of a cigar from the top of one bracket to the bottom of the next tax bracket could result in a tax increase disproportionate to the price increase. An example of this was the increase in tax from $4 to $7 per thousand between cigars intended to retail for 6 cents and those intended to retail for more than 6 cents and not over 8 cents. At the 6-cent level, the tax was 6.7 percent of the retail price and 10.4 percent of the manufacturer's net price (exclusive of tax). If the manufacturer of a 6-cent cigar raised the stated retail price to three for 20 cents, the effective rate of tax would have increased to 10.5 percent of the retail price and 17.5 percent of the manufacturer's net price. The manufacturer would have netted only $1.70 more per thousand cigars although consumers would pay $6.67 additional. This bracket system not only discriminated among producers depending on the price at which they sold their cigars within a bracket but also prevented manufacturers from freely adjusting prices to meet cost changes. There is no way to determine precisely how the burden of the cigar tax is distributed between consumers and owners of manufacturing firms. In either event, however, the prior tax was discriminatory. To the extent it is borne by consumers, the burden imposed by the tax varied erratically depending on the intended retail price of the cigars purchased. To the extent it is borne by manufacturers, the burden of the tax varied depending on the particular price lines produced by each manufacturer. As a percent of sales, the tax paid was least for those manufacturers whose production is concentrated in price classes where the effective rate of tax is at a minimum. These problems of the bracket system have been recognized for a long time by the cigar industry, the Treasury Department, and the Congress. When the tax on cigars was collected by means of the purchase of stamps, practical consideration favored the use of some type of bracket system in order to keep to a reasonable level the number and denomination of stamps that had to be printed. However, the use of stamps as evidence of payment of tax was discontinued in June 1959. As a result, there was no reason why the bracket system should not be eliminated. A change from a tax base of the intended retail price to a base of the intended wholesale price makes administration of the tax easier and avoids many of the problems associated with the prior tax base of the intended retail price in the cigar's principal market. Administration of the tax will be facilitated because wholesalers traditionally sell a given cigar at the same price to different retailers. Retail prices do not have this consistency. In addition, verification that sales actually take place at the list price will be easier than in the case of the intended retail price because there are far fewer wholesalers than retailers. With a tax based on the wholesale price rather than the retail price, a rate of 10 percent is required in order to produce the same tax yield as is produced under prior law. However, if a substantial tax increase is not to result for many cigars, a rate which is lower than this is required. Substitution of an ad valorem rate of tax for the prior bracket 1 This assumes the usual standard markup in determining the retail price. system, of necessity, has a differing impact on individual firms within the cigar manufacturing industry. An ad valorem rate set at 10 percent of the wholesale price would mean that those firms which have produced cigars which sold at prices where the tax rate was relatively low under the bracket system would be faced with a tax increase with such a rate. Firms producing cigars at prices where the tax rate has been relatively high under the bracket system, of course, would obtain some benefit under a 10-percent rate structure. In a transition of this type, however, in order to prevent a tax increase for a large number of lines of cigars, a reduction in the average rate of tax is necessary. In addition to the need for a tax rate decrease because of a shift to an ad valorem system, a decrease in the rate of tax for cigars also is justified for other reasons as well, First, when many excise taxes were reduced or eliminated in 1965, the tax on cigars was nevertheless maintained at preexisting rates. Second, the cigar industry in recent years has been experiencing considerable financial difficulty. Sales have dropped dramatically from 9 billion cigars in 1964 to about 6 billion in 1975 a period of rising costs. Explanation of provision The Act changes the prior law tax on large cigars (those weighing more than 3 pounds per thousand 2) to a tax of 812 percent of the wholesale price, but not more than $20 per thousand cigars. Wholesale price, as defined in the Act, means the manufacturer's or importer's suggested delivered price of the cigar to retailers (including in this price this Federal cigar tax). This price is to be determined before any trade, cash, or other discounts, or any promotion, advertising, display, or similar allowances. Generally, this wholesale price is the traditional manufacturer's or importer's declared intended catalog or list delivered bulk price to retailers. Where the manufacturer or importer has no suggested delivered price to retailers for the particular cigar in question (as may happen, for example, if he sells only at retail, or where the suggested delivered price to retailers is not adequately supported by bona fide arm's length sales), the Act provides that the wholesale price is to be determined by the Treasury Department on the basis of the price for which cigars of comparable retail price are sold to retailers in the ordinary course of trade. In most cases the wholesale price will be adequately supported by sales by the wholesalers to retailers. In only a few situations will it be necessary for the Treasury Department to determine the wholesale price on the basis of the price for which cigars of the same or comparable retail price are sold to retailers in the ordinary course of trade. The use of the intended wholesale price as the tax base will eliminate the troublesome determination of the retail price of a single cigar in its principal market. The wholesale price does not include State or local taxes imposed on cigars as a commodity. The prior law exclusion of such taxes from the tax base is continued by this provision. If a manufacturer normally includes State or local taxes in his "wholesale price," he must 2 Small cigars are not taxed on the basis of price. Their tax rate is 75 cents per thousand. show the price net of any such taxes in a manner satisfactory to the Treasury Department for the purpose of imposing the tax provided by the Act. The Act also amends the Code (sec. 5741) to include importers among those persons required to keep records prescribed by the Treasury Department and to provide that the required records be available for inspection by internal revenue officers during business hours. The existing statutory requirement is extended to importers in order to avoid any doubt that appropriately prescribed regulations may require them to keep records which are needed. This is particularly relevant with the change in manner of imposition of the tax on large cigars and the added definition of "wholesale price" which will likely result in a requirement that records be kept by importers. Effective date The new ad valorem tax becomes effective on the first day of the first month which begins more than 90 days after the date of enactment of the Act (i.e., February 1, 1977). Revenue effect This provision will reduce budget receipts by $7 million in fiscal year 1977, $7 million in fiscal year 1978, and $7 million in fiscal year 1981. 29. Treatment of Gain from Sales or Exchanges Between Related Parties (sec. 2129 of the Act and sec. 1239 of the Code) Prior law Under prior law, recognized gains from a sale or exchange of depreciable property were denied capital gain treatment (and taxed as ordinary income) if the transaction was between a husband and wife, or between an individual and a corporation over 80 percent of the value of whose stock was owned by the individual, his spouse, and his minor children or grandchildren (sec. 1239). This rule applied where the shareholder sold property to his controlled corporation, or vice versa. Although the statute covered a sale or exchange "directly or indirectly" between an individual and a controlled corporation, several courts had held that this language does not reach gain on a sale of depreciable property between two corporations each of which is more. than 80 percent controlled by the same individual and his family. These courts refused to follow a ruling by the Internal Revenue Service that a sale between two such commonly controlled corporations is (for purposes of this provision) "indirectly" a sale between the individual and the corporation.1 Reasons for change In enacting section 1239 (and its predecessors in the 1939 Code), Congress sought to prevent the practice of selling a low basis-high value depreciable asset to a controlled corporation in order to "step up" the basis of the asset for depreciation purposes in the hands of the corporation at the cost of a capital gain tax to the selling share 1 Rev. Rul. 69-109, 1969-1 C.B. 202. |