"(2) the stock so received was received by the shareholder without inclusion with respect to such stock of any amount in the income of or recognition of gain or loss to such shareholder under section 305 or section 371, or

66

(3) the stock so received was received by the shareholder in a distribution in redemption of stock of a personal holding company as defined in section 542 and was stock of a value at the applicable date for determination of the value of the gross estate of such decedent

"(A) more than 35 percent of the value of such gross estate, or "(B) more than 50 percent of the taxable estate of such decedent. For the purposes of this paragraph, stock of two or more corporations, with respect to each of which there is received in a distribution 50 percent or more in value of the outstanding stock, shall be treated as the stock of a single corporation.

"(d) LIMITATION ON TOTAL DISTRIBUTIONS.-Distributions of property treated as in full or part payment for stock under subsection (a) or subsection (b) shall be so treated only to the extent that the total amount of such distributions is not in excess of the sum prescribed in paragraphs (1) and (2) of subsection (a), provided, that in determining such total amount the amount of a distribution in subsequent redemption of stock received in a distribution described in paragraph (3) of subsection (c) shall be taken into account only to the extent of the excess of such amount over the value of such stock at the date so received."

SUBCHAPTER C-DEFINITION OF LIQUIDATION

Section 336 of the proposed code defining "partial liquidations" contains a requirement that separate books and records must have been maintained by the corporation for the part of its business which is being distributed in liquidation. This is an addition to the requirement that the part of the corporate business being distributed constitutes a separate business and has been operated separately from the other businesses of the corporation for a period of 5 years preceding the distribution.

The separate records requirement seems to be a surplusage if the other facts of separateness are established, and also will no doubt frequently constitute a discriminatory trap for small businesses. Large corporations would doubtless have no difficulty in meeting this requirement and would be adequately alerted by their advisers that the requirement must be met. However, small businesses are not only less likely to keep books of account and records to the precise extent required by this provision, but for obvious reasons are not constantly advised by lawyers and accountants as to refined technicalities of tax law. There is little difficulty in the view that it would be unjust for a small corporation maintaining two clearly separate businesses for the requisite 5-year period to be deprived of the right to a partial liquidation because of unfamiliarity with this provision until the time for liquidation arrived.

It is submitted that this provision should be stricken from section 336.

SUBCHAPTER G-ACCUMULATION OF SURPLUS

Subchapter G incorporates the provisions now found in section 102, imposing a penalty tax for accumulation of earnings and profits for the purpose of avoiding surtax on shareholders.

There is one important defect in the proposed new provisions, consisting of the omission under section 535 to permit deduction of the 85-percent transfer tax imposed by section 309 in determining the net income subject to the penalty tax. As section 535 reads, a corporation could pay the 85-percent tax on redemption of preferred stock, and then, if the penalty tax on accumulated earnings were imposed for the same year, pay a 381⁄2-percent tax on the same amount paid to the Government for the 85-percent tax.

The new provisions also have not remedied a major defect and inequity existing under section 102 of the present code. This is the taxation of accumulated earnings for a taxable year which are retained by the corporation for clear and unquestioned business reasons and needs, if there are additional earnings also retained which it is established are not retained for business purposes. This is a familiar defect, and is simply illustrated by stating that if a corporation needs to retain $90,000 for unquestioned business requirements, but retains $100,000, the penalty tax is imposed upon the full $100,000. This has never made any sense, and correction of the defect is the type of correction for which the revision was undertaken and for which there was a crying need.

It is submitted that both these defects be eliminated by appropriate amendment of sections 531 through 536.

SUBCHAPTER J-65-DAY RULE

Subchapter J dealing with taxation of estates and trusts eliminates the socalled 65-day rule contained in the present law. Under present law, distributions by trusts and estates in the first 65 days of 1954 are deemed to be distributions to beneficiaries on December 31, 1953, and accordingly taxable to beneficiaries as 1953 income. Many such distributions have been made by trusts and estates, and tax returns of both the fiduciaries and the estates for 1953 have been filed in reliance upon this present law.

Subchapter J proposes to change this rule and by section 683 of the proposed code retroactively with respect to distributions made in the first 65 days of 1954. This result would not only be in conflict with returns that have been filed, but would impose a penalty in the form of additional tax liability upon estates and trusts involved. The 65-day distributions are deductible by the estates and trusts in computing their tax liability, and this deduction would be lost with a consequent increase in overall tax liability for fiduciaries and beneficiaries for 1953.

It is submitted that it is undesirable and inequitable to change the tax rules retroactively in this respect, particularly when tax planning and tax returns have been in reliance upon present law. It seems particularly inappropriate since the proposed retroactive change will make the law effective for the year 1953, which is an extent of retroactive effective date approach which is most

extreme.

SUBCHAPTER J-INCOME DISTRIBUTED OR HELD FOR GRANTOR

Section 677 of the proposed code takes the place of section 167 of the present law, which taxes to the grantor income of a trust which is or may be distributed or held for distribution to the grantor. Under section 167 the courts have held that income used to discharge a legal obligation of the grantor is taxable to him. This has been applied in a few cases covering situations where the grantor has borrowed money and utilized the trust to make payment of the loan. It has never been applied to a situation where the grantor has transferred property by gift to a trust, subject to the liability for gift tax on the transaction. Many such transfers have been made without challenge, but the risk that 167 would be applied has also prevented gifts of this type being made.

It seems doubtful that 167 is intended to apply to such gift transactions for several reasons. Such gifts are common when made outright to individuals and not in trust, and it is clear that payment of the gift tax by the donee does not make the income from the property given taxable to the donor. This is also true as to other types of liabilities, such as where property subject to a mortgage is made the subject of a gift, in which case it is clear that payment of the mortgage by the donee involves no tax to the donor. However, gift-tax liability is of a type even less appropriate to cause such tax liability, since it is a joint liability of both the donor and the donee under the code. The liability for tax is a lien against the property given and the donee is secondarily liable for the tax. If the tax is not paid when due, the donor and donee both have a primary joint liability for the tax.

It is therefore submitted that the proposed section 677 should be revised to include provision that discharge by a trust of liability for gift tax subject to which the gift is made to the trust, will not be deemed to be a distribution of income to the grantor. This provision would state what appears to be present law, but eliminates a troublesome uncertainty. It would also put grantors of trusts clearly on an equal basis with donors of gifts made outright and not in trust.

SUBCHAPTER J-CLIFFORD RULE

The new provision for estates and trusts incorporates the so-called Clifford rule regulations with respect to taxation of grantors of trusts. Section 675 (3) provides that the grantor shall be taxed with the income of the trust in each case where he has borrowed from the trust and not completely repaid the loan and interest before the beginning of the taxable year. The one exception is where the loan has adequate interest and security, and is made to the grantor by a trustee other than the grantor or a related trustee subservient to the grantor. This would penalize grantors who for bona fide reasons have made loans, even for a short period, for a perfectly sound security and bearing adequate interest,

so long as there is a related trustee, either acting alone or as cotrustee with an independent trustee, as long as the related trustee is deemed to be subservient to the grantor. Since the question of determination or claim of subservience by the tax authorities is one fraught with uncertainty and entirely unpredictable, grantors will find themselves in perfectly valid situations unable to make necessary loans because of the risk of assertion of income-tax liability. The liability could accrue even in a situation where the grantor had made a thoroughly sound loan for a period of 3 years, and had 90 percent of the loan repaid by the beginning of the third year. In such case, all the income of the trust would be taxable to the grantor during the third year, even though full repayment was completed on January 2 of the third taxable year.

It seems that prevention of tax avoidance would be adequately served if borrowing were permitted in any case where the loan was for adequate security and interest and was made by a trustee or trustees other than the grantor. As the provision now reads, a loan made by a corporate trustee and a related trustee acting jointly in the decision to loan could create the tax liability. Therefore, without detracting from the foregoing recommendation, it would seem that at least this type of loan should be permitted.

The CHAIRMAN. Mr. Walter Mack, please.

Sit down and make yourself comfortable, Mr. Mack, and identify yourself to the reporter.

STATEMENT OF WALTER MACK, PRESIDENT, NATIONAL

PHOENIX INDUSTRIES

Mr. MACK. Thank you. My name is Walter Mack. I am president of National Phoenix Industries, which is a publicly held company with about 18,000 stockholders, listed on the American Exchange and actively traded.

We have a number of wholly owned subsidiaries, one being Nedicks, a chain of snack bars feeding about 50 million people a year. We also own control of the B. & G. Sandwich Shops, which are known throughout the country.

We have another wholly owned subsidiary of which I am also president, known as Cantwell and Cochran, who are in the process of manufacturing and canning soft drinks in cans for the entire country, with quite a number of plants.

Senator Millikin and members of the committee, I appear here today to acquaint you with a hardship case which has suspended us in midair, and we can't move ahead until the situation is clarified.

In our growth, we had last year worked out an arrangement for a tax-free reorganization with the Croft Co. of Boston under the old revenue law. We were advised by two different sets of tax lawyers that the transaction was a tax-free reorganization, and we went out and signed an agreement last year, in December, presented the plan to the SEC in January, and after they had passed on it, called the necessary meetings of the two companies. The Croft Co. is also a publicly held company, with 6,000 stockholders, listed on the American Exchange.

The CHAIRMAN. What is their business?

Mr. MACK. They used to be the old brewing company and own. a large building, real estate, and manufacturing and canning facilities in New England, which would or could be used for our expansion purposes, of Cantwell and Cochran.

They have discontinued and sold the brewery company to another brewer in Boston, so they are no longer in the brewing business, although they own the facilities.

The plan was consummated with their directors and submitted to their stockholders for a vote of approval. Their stockholders met on February 24 and approved the plan of reorganization. The plan was submitted to them on the basis that it was a tax-free transaction, and also was submitted to them under a written plan in which the reorganization had to be consummated by April 30 of this year. It was submitted to my stockholders for approval at a stockholders meeting on March 3, and was unanimously approved, or tremendously approved by 78 percent of the stockholders voting for the plan on March 3.

The plan was presented to National Phoenix stockholders also in writing as a tax-free reorganization to be consummated on or before April 30.

What has happened is that under the new revenue law, section 391, subchapter C of chapter I, which nobody—at least I am advised nobody knew a thing about it until it was published on or around March 9, so there was no way we could have protected ourselves-made the transaction, now, a taxable one, so that we have a plan approved by all stockholders, we are ready to transfer the assets, and find ourselves suspended and unable to do anything because the new regulation makes it taxable effective to March 1, and our last meeting took place on March 3. We are therefore suspended in the position that we can't move ahead and if something isn't done by April 30, all our work, expense, plans, and representations cannot be gone along with because under the new bill it is taxable.

We acted in good faith under existing law and I come to you to ask your help in trying to rectify the situation because I know there have been certain assurances given that that was not the intention to put anybody in that position, and I am sure everybody is aware that House Chairman Reed, on the first day of the hearing made the committee aware of his feeling that the result of which I am claiming was in error and should be corrected, and that your expert, Colin Stam, has also, I believe, prepared a statement that has been approved by the Treasury Department, that there was an error in the situation. It was never intended it would be retroactive to a transaction of that sort.

I come to you to plead, because I am told by my taxmen that the only way it can be rectified is by the Senate Finance Committee acting because the bill as it is written, while this may be in error, it is really up to the committee to rectify that situation. Therefore, I come to you personally to acquaint you with the manner in which we are suspended in midair, with a contract that terminates on April 30, and ask you if you would in some way give it your early consideration in your executive sessions so that the public and people in my position can be acquainted with what you are thinking of, if possible, before the 30th of April.

The CHAIRMAN. Thank you very much, Mr. Mack.

Mr. MACK. Thank you for letting me come here and plead my case. The CHAIRMAN. We have been glad to have you.

Mr. MACK. May I file this?

The CHAIRMAN. Please do.

(The prepared statement of Mr. Mack follows:)

STATEMENT OF WALTER S. MACK

My name is Walter S. Mack. I am president of National Phoenix Industries. I appear before this committee to acquaint it with a hardship case resulting from the provisions of subchapter C of chapter I of subtitle A of H. R. 8300, the pending tax bill. Section 391 makes these provisions retroactive to March 1, 1954, and makes our corporate transactions of the last 3 months taxable when they were not taxable under existing tax law at the time we undertook them. Take our particular case.

Under the old law, the Internal Revenue Code of 1939, the transfer by National Phoenix Industries of all of its assets for stock of the Croft Co. was a nontaxable reorganization.

Being so advised by eminent tax counsel, and operating under the old law, National Phoenix and Croft entered into a contract, on January 15, 1954, under which National Phoenix agreed to transfer its assets for stock of Croft, if approved by the Securities and Exchange Commission and the respective stockholders of the two companies.

The plan of reorganization was promptly submitted to the Securities and Exchange Commission prior to the end of January, so that the legal notices to stockholders could be sent out prior to the end of that month.

Notices were immediately sent, and on February 24, 1954, the stockholders of Croft, numbering over 6,000, approved the plan.

On March 3, 1954, the 18,000 stockholders of National Phoenix overwhelmingly approved the plan. Mind you, this was not a plan of reorganization by closely held or family corporations. Both were publicly owned corporations, the stock of both of which is listed and traded on the American Stock Exchange.

By the contract, as approved by the stockholders, the transfers of assets and stock were required to be made on or before April 30, 1954, and the transaction, as I have said, was not taxable under existing law.

Then, on March 9, out of the clear blue sky, came H. R. 8300, which makes the whole transaction taxable because everything had not been completed prior to March 1, 1954.

We-National Phoenix and Croft-acted in good faith, under existing law. The directors advised their stockholders, on the basis of the advice of company counsel, that under existing law this was in every way a tax-free reorganization. Today we cannot perform the contract because the law proposed, as passed by the House, makes the transaction taxable.

The Senate committee was advised by its chairman, on the first day of the public hearings, that Hon. Daniel Reed, chairman of the Ways and Means Committee, feels that the result of which I complain was an error and should be corrected. In that statement, prepared by your expert, Colin Stam, the Treasury Department agrees that this is an error and should be corrected.

However, I am in this position. I am advised by my counsel that, notwithstanding all of this, the bill, as it passed the House, must be changed by the Senate, and if unchanged, that we cannot proceed to carry out our contract on April 30.

I am therefore here, appealing to your committee to make the required change in H. R. 8300 so that the law under which we were acting shall remain the applicable law to the transactions I have described.

I realize that the Senate will have to accept the change, as well as the conferees of the House, but I feel that what I ask is so eminently fair that once this committee has acted in the right direction, the others will readily go along. The public statement of Mr. Reed, of the Treasury Department, and of Mr. Stam, support my opinion in this respect. Thus, the action of this committee is the key to our entire problem.

Apparently other organizations and the financial community are upset, and at a standstill, due to the present uncertainty. The situation is such that it is submitted that your committee could and should promptly meet, agree upon, and make a public announcement, as soon after the public hearings as possible and prior to April 30.

Thank you.