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Advantages to the acquiring corporation include: 1. Diversification. 2. Acquisition of capable management. 3. Expansion which might otherwise require many years to effect.

4. Economies resulting from combined operations, resulting in increased net profits.

5. The elimination of losses usually incurred in launching a new enterprise.

All of these considerations are vital to the business involved, and generally result in higher taxable corporate income for the Government.

In the report of the Committee on Ways and Means, the sole justification for section 359 is contained in the following statement:

Publicly held corporations usually have a corporate existence separate from that of their shareholders and, as a rule, do not merge or consolidate with a view to the tax advantages which may result therefrom at the shareholder level. There is ample evidence, however, that closely held corporations may undertake these transactions solely in the hope of distributing earnings to shareholders at capital gains rates.

It appears from the aforementioned statement, that Government is requesting legislation to kill dozens, maybe hundreds, of legitimate transactions, when it already possesses more direct means to deal with the situation which section 359 attempts to reach by indirection. Section 102

may be invoked in cases of unnecessary accumulation of surplus, which may be taxed as provided in the act. If surplus is necessary in the conduct of a business, it will not be paid out, in any event, and no tax will arise at the stockholder level.

Thé CHAIRMAN. Give us an example of your operations. Mr. HERRMANN. The operation of the corporation that I — The CHAIRMAN (interposing). Your National Association of Shoe Chain Stores.

Mr. HERRMANN. Our National Association of Shoe Chain Stores represents practically all of the accredited shoe chains in the United States. We endeavor to implement a program of research for the benefit of the association members. We endeavor to interpret legislation for the benefit of the association's members. We run a style show each year for the purpose of creating general style uniformity in the industry, and giving the association's members the benefit of research by expert stylists who are hired to do a job which some members could not afford to pay for.

The CHAIRMAN. What is the financial relationship between your association and the Foot Comfort Shoe Store of Keokuk, Iowa ?

Mr. HERRMANN. The financial relationship of the association to the average shoe store is on a basis of dues, very low dues, which are predicated on covering the expenses of the association. It is a nonprofit association, and it is an association that is run entirely for the benefit of its membership.

The CHAIRMAN. Do you direct their operations?

Mr. HERRMANN. We have an executive secretary, Mr. Edward Atkins, who actively directs the operation. We elect new officers, every 2 years, who are representatives of the association's member companies.

The CHAIRMAN. What is the obligation of the shoe store toward the association ?

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Mr. HERRMANN. The obligation of a shoe store toward the association is voluntary. The stores, or the chains, pay dues up to approximately $2,000 for the larger chains, based on the size of the company and starting with $100, which is a nominal membership. The CHAIRMAN. You don't own any of the stock? Do


have any ownership interests, stock or otherwise, in any of the companies that you serve?

Mr. ATKINS. Mr. Senator, may I interrupt?

Mr. ATKINS. I am Edward Atkins, executive vice president of the association. I think I sense the direction of your question. May I say this: No officers of the association, neither paid or unpaid, own stock in other members of the association, except the companies which they happen to be affiliated with. The association, itself, controls no stock in any member company. Is that your question?

The CHAIRMAN. I believe so. I am still somewhat confused.

Mr. ATKINS. We are just a typical trade association like several thousand others. The association, itself, has no financial control over any

of its members. The CHAIRMAN. Proceed, please. Mr. HERRMANN. Thank you.

Up to the present time, it has been regarded economically and legally sound to put one's estate in good order, to create maximum liquidity, so that the heirs and, incidentally, the Government's interest in estate taxes, are adequately protected.

If section 359 becomes law, two lamentable results are inevitable. A business, which might otherwise be merged with another, will not be, because of the tremendous tax impact on stockholders. It will face the possibility of sale subsequent to the death of one or more key stockholders, in order to meet estate taxes. It may be sacrificed under pressure, a lower estate valuation will result, and the Government will incur a loss in revenue.

Or, the business may be merged with a publicly held corporation; the profit to the stockholders of the transferor corporation will be taxed at capital gains rates based on the market value of the stock exchanged, and more often than not, a large block of the stock received will be sold within the fiscal year to satisfy the tax liability accruing. This might easily depress the market, affecting thousands of innocent stockholders. As a result, stockholders of many companies, aware of these consequences, will become reluctant to approve mergers, regardless of corporate advantage.

In the case of highly desirable acquisitions, purchase prices would have to be stepped up to meet the tax liability resulting from the exchange. It is quite conceivable that in the cases of many closely held corporations whose stocks carry a characteristically low base, the purchase price would have to be advanced as much as 33 percent. This would tend to make many worthwhile mergers impossible to complete.

Many closely held corporations, especially the type most likely to be involved in mergers, are relatively large, with their shares actively traded on the exchanges, or over the counter, and with their stock widely distributed and held by thousands of stockholders, and I am at this point citing an example with which I am very familiar.

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The following example is by no means unusual in the case histories of consolidations or mergers. Corporation X, a closely held corporation, according to the definition in section 359, was merged, in 1952, with corporation Y, a publicly held corporation, in a statutory consolidation.

Corporation X had approximately 475,000 common and preferred shares outstanding, a net worth over $7 million, and a list of about 2,000 stockholders. Corporation Y had 2,400,000 common shares outstanding, a net worth of $23 million, and over 15,000 stockholders.

There were a number of advantages for both organizations inherent in the merger: Diversification, a new medium of expansion, and the ecquisition of management with a fine record of achievement, evidently motivated the larger corporation. Increased efficiency, the backing of larger resources for an expansion program, and greater marketability for the stock evidently motivated the smaller corporation.

If section 359 were then law, the merger would not have occurred. Stockholders of the smaller corporation would not have assumed the tax burden. Stockholders of the larger corporation would have been reluctant to create a situation whereby large blocks of stock would have to be thrown on the market to meet the tax obligation. Thousands of stockholders would have been penalized.

The real loser, however, would have been the United States Government.

The annual dividends on the common shares of stock of the X corporation have been increased from $1.45 per share annually to $1.80 per shade. The value of the common shares of the X corporation has risen from $17 to $29, with an obvious comparable increase in potential estate taxes.

There is no greater justification for taxing stockholders because they changed certificates pursuant to a statutory consolidation, or merger, under section 112 (g) than there is to tax a stock dividend. No real profit can accrue in either instance until the stock is sold.

The stated purpose of section 359 is to prevent the distribution of earnings at capital gains rates. But despite this statement in the report, the section then proceeds to impose a tax on the exchange at those very capital gains rates, not only on accumulated earnings, but on the entire amount of stock received in the exchange, to the extent that the value of such stock represents an accretion in value over its original base.

Actually, this section imposes a tax on capital. The surplus, and even that part of the capital stock which might have resulted from a transfer of surplus to capital, was taxed at normal and surtax rates in the years in which the earnings occurred. It is now in danger of being doubly taxed at capital gains rates before a share of stock is sold, or a dollar of real or liquidated profit is realized.

The proposed section is invidious in its implications. It differentiates between small business and big business. It forbids, or penalizes, the stockholders of a closely held corporation from realizing greater marketability for their stock holdings through consolidation, or merger, and in the same section, gives a green light to publicly held corporations.

We should not labor under any illusion about publicly held corporations. They merge for the same justifiable business reasons; but

there are few mergers wherein the stock of both corporations enjoy equal marketability. Certainly, the stockholders of the publicly held corporation, whose shares are less active, less marketable, and would tend to depress the quotation on any sizable offering, should not be accused of attempting to distribute surplus at capital gains rates through the device of the merger. There is no more justification for impugning the motives of a closely held corporation.

Section 359, in essence, singles out stockholders of closely held corporation, and states: You can't make your stock more marketable through consolidation, unless you pay the full tax on the corporate surplus and any capital accretion before you died. On evaluation, the Government might discover this to be an expensive philosophy. Stocks of closely held corporations, with debatable market values, are always difficult to appraise. They are often the subject of controversy, compromise, or litigation, for the levying of an estate tax. Stocks of a publicly held corporation have a specific market value, which minimizes the problem inherent in appraisals and subsequent collection of tax.

The provisions of section 359, and related sections, insofar as they apply to consolidations and mergers, are unjustifiably punitive. They are more regulatory than revenue producing, and will stifle normal business practices which have built some of our greatest industries.

An even greater inequity exists in the case of a contemplated merger between 2 closely held corporations wherein the stockholders of 1 corporation would not receive in exchange at least 20 percent of the stock—after consolidation-of the acquiring corporation. The stockholders of the transferor corporation would be confronted with a capital-gains tax on all of the stock received in exchange, without the availability of a ready market to liquidate sufficient stock to meet their tax liability.

To illustrate the vital interest of the retail industry, the following statistics are important:

According to information of the Securities and Exchange Commission, there are 250 retail companies listed on the exchanges, and I might add at this point, Mr. Chairman, that applies to corporations, rather than companies. A number of these might not meet the definition of "publicly owned.” The latest available compilation of the Internal Revenue Division indicates 112,000 retail companies filed returns in 1948. Section 359 may appropriately be construed as legislation inimical to the interest of over 111,000 retail companies. These so-called small business establishments constitute the major portion of the retail industry.

I have been informed that witnesses who appeared before the Senate Finance Committee have advocated postponing the effective date of section 359, which is specified as March 1, 1954. This suggestion has evidently beeen offered in the spirit of compromise. I could not, in due conscience, oppose a postponement. Undoubtedly, a number of mergers and consolidations were in process as of March 1. We all know, that as a result of SEC regulations, such transactions require considerable time for consummation. Any type of retroactivity would involve tremendous losses and undue hardship to the parties involved, who had good reason and justification to rely on the statutory provisions of section 112 (g) in the Revenue Code, as it existed prior to March 1, 1954.

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However, the provisions of section 359 are inequitable, oppressive, uneconomic, and unsound as a revenue-producting device. They are either right or wrong, and should be completely stricken from the code. There should be no compromise with poorly conceived legislation.

I sincerely doubt if legislators responsible for the inclusion of this section had sufficient time to evaluate its effects properly. I think, eventually, it will be realized that the results of these provisions, in no way, carry out their intentions, or represent the solution they hope to achieve. Although it represents a perfectly obvious conclusion, at. this point, I would like to state that the substance of the present provisions of section 112 dealing with mergers and consolidations should be renewed and retained in the code.

Mr. Chairman, we have requested time to express our opposition to section 6016, relating to the declaration of estimated income tax by corporations. We believe that this section directly effects an increase in corporate taxes at a time when reductions were anticipated and, incidentally, deferred. However, in the interest of time, and to avoid duplication, the views of the National Association of Shoe Chain Stores will be presented by the American Retail Federation, scheduled to appear before this committee at a later date.

Senator LONG. Might I just ask you to give me an illustration of what you have in mind when you tell me how these consolidations would be affected under the law as it stands, and how it would be if section 359 becomes law? I would just like for you to illustrate the difference so I can get it straight in my mind.

Mr. HERRMANN. Well, reverting to the example contained in this presentation, preferred stock was exchanged for preferred stock; common stock was exchanged for common stock. The stockholders received stock in identically the same proportions as they held stock prior to the consolidation in the transferor corporation, and none of that stock which was received in accordance with the plan of statutory tax-free consolidation was taxable to the stockholders.

Senator Long. Was that a corporate reorganization or a merger?

Mr. HERRMANN. That was a merger. The transferor corporation was subsequently liquidated and became part and parcel of the acquiring corporation.

The total of 450,000 shares of common stock, which was the capitalization of the transferor corporation before the merger, and 25,000 shares of preferred stock, would not have constituted the 25 percent requirement before consolidation, or 20 percent subsequent to consolidation of the 2,400,000 shares outstanding in the acquiring corporation.

Consequently, stockholders would have been confronted, in that particular situation, with the necessity of rejecting the merger. That merger never would have been concluded because it would

have been folly to file an application or a plan of statutory consolidation, there, in view of the fact that all of the stock received by the stockholders of the transferor corporation would have been subject to a capital gains tax.

Senator Long. Now, if I understand you correctly, as it stands today, that transaction is a tax-free transaction; there is no profit or gain on it; it is a simple consolidation or merger of two corporations, is that right?

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