of being refunded. If these particular issues had first-call dates no earlier than 3 years from date of issue, such refunding would not now be possible.

In order not to hamper the financing necessary to support the construction program now under way in the gas industry, currently estimated to cost $2.3 billion in 1954–55-56, it is requested that this provision be modified to overcome the objection outlined above.

As a minimum, it is urged that the provision be made effective no earlier than the effective date of the Internal Revenue Code of 1954.

Section 172-Net operating loss deduction (computation of net operating loss) Section 122 of the Internal Revenue Code of 1939 provides a net operating loss carryover to other years. However, before this loss carryover may be applied as a deduction to taxable income the following adjustments are required to be made to both the taxable year in which the loss occurred and to the net income of each year or years to which the loss may be applied:

1. The excess of percentage depletion over cost depletion must be restored. 2. Wholly tax-exempt interest, less any nondeductible interest paid or accrued to carry the exempt securities must be included in gross income.

3. The net operating loss deduction must be restored.

4. No deduction or credit is given for intercorporate dividends received. These adjustments to both the year of the loss and the year to which it is carried purported to be justified on the economic-loss theory. However, income taxes are not paid on economic income, but on taxable income, and sound principles of taxation should provide that the carryover provisions apply to taxable income and not to economic income concepts.

Section 172 of H. R. 8300 provides some changes in the above method of computing net operating loss. It eliminates entirely the adjustment for tax-exempt interest received, and while it continues the adjustments for other items in the year giving rise to the loss, it does not require them for the first year to which the loss is carried. This is a partial recognition of the inequities which at present exist in the operation of the loss carryover and carryback provisions, but it does not cure them. The economic loss theory is still retained in part.

The adjustments which are still required in determining the net operating loss under H. R. 8300 by companies having such transactions result in higher taxes being paid by some risky businesses which incur losses in some years, than is paid by less risky businesses with more stable income, and such a result cannot be justified under any equitable theory of taxation.

Therefore it is strongly urged that the adjustments be eliminated not only for the taxable year in which the loss occurred but also for each year or years to which the loss may be carried.

Section 243.-Deduction for dividends received by corporations

Section 243 of H. R. 8300 provides that in the case of a corporation, there shall be allowed as a deduction an amount equal to 85 percent of the amount received as dividends. The deduction allowed by this section is limited by section 246 (b) to an amount not in excess of 85 percent of taxable income. The deduction allowed under this section merely replaces the credit provided in section 26 (b) (1) of the present Internal Revenue Code.

Thus, H. R. 8300 fails to correct the inequity which was recognized by the President in his message to Congress on January 21, 1954, in which it was stated, "I also recommend that the penalty tax on consolidated returns and intercorporate dividends be removed over a 3-year period." The gradual elimination of this inequity, in line with the President's recommendation, could be accomplished by increasing the deduction to 90 percent for the year 1954, 95 percent for the year 1955, and 100 percent thereafter.

Historically, payments of intercorporate dividends have been treated for Federal income-tax purposes as nontaxable transfers of funds from one corporation to another. Prior to the Revenue Act of 1936, a corporation receiving dividends was allowed a deduction in the amount of 100 percent of such dividends and thus incurred no tax thereon. This deduction was allowed because a corporate tax had already been paid upon the earnings which were distributed as dividends. In 1936, with a corporate income tax rate of only 15 percent, the effective tax rate on intercompany dividends was only 2.25 percent. Under the present 52 percent tax rate, the effective rate on intercompany dividends is 78 percent. Thus, the burden of this economically unsound tax has become much more serious than when first imposed.

The only reason for and the only possible justification for taxing intercorporate dividends is contained in a message to Congress by the President of the

United States dated June 19, 1935, in which the then President recommended the substitution of a corporation income tax graduated according to the size of corporation income in place of the then uniform rate of 13 percent. The President followed this recommendation with the following:

"Provision should, of course, be made to prevent evasion of such graduated tax on corporate incomes through the device of numerous subsidiaries or affiliates, each of which might technically qualify as a small concern even though all were in fact operated as a single organization. The most effective method of preventing such evasions would be a tax on dividends received by corporations." This reason, however, should not be controlling as regards the taxation of a public-utility system. In many instances, a regulated public utility is required to furnish part of its services through the medium of subsidiaries. For example, some States require that a utility operating within their geographical limits shall be incorporated within the particular State, even though the separate corporation is a part of an integrated utility system operating in several States. The result is that a separate utility corporation must be set up within the limiting State. In other cases, the use of a subsidiary to supply part of the service, or some of the facilities through which the service is supplied, is required because of joint ownership of property, franchise requirements, or similar causes over which the regulated public utility has no control.

The situations outlined above have prevented many utility companies from merging into one single corporation. In these cases, the utility must, under the present provisions of the Internal Revenue Code, either file a consolidated return, and pay a penalty tax of 2 percent, or pay tax at the rate of 7.8 percent on dividends received from its subsidiaries. There is no real justification for either the penalty or dividend tax, since the utility is forced to pay a Federal tax penalty because of the requirements of State or local law, or other conditions over which the utility has no control.

The following example will illustrate the real burden of tax as corporate earnings pass through the hands of other corporations before distribution to the beneficial owners.

Corporation P (parent company) owns 90 percent of the voting stock of Corporation S. Under existing law, because of the lack of 95 percent stock ownership, neither of the corporations can be included in a consolidated return. Thus, the full impact of the tax on intercompany dividends must be borne under the present law. Here is what happens:

Corporation S with a net income before tax of $1,000,000 pays a tax of__ $520,000 And out of its net income after tax pays $432,000 ($480,000 × 0.90) in dividends to Corporation P.

Corporation P pays a tax of 7.8 percent of its dividends from Corporation S, or a tax of $432,000 × .078_--

Thus, the total tax paid is

33, 696 553, 696

In the above example, an effective tax rate of more than 55 percent has been paid. If the system had been operated as a single corporation, the effective rate would not have exceeded 52 percent. Yet the difference between an affiliated group of utilities and a utility which has been able to consolidate all of its operations into a single corporation is only a matter of form.

This obvious inequity should be corrected by eliminating the present tax on dividends from one domestic corporation to another. In the absence of immediate discontinuance of this tax, it is urged that the deduction be increased to 90 percent for the year 1954, 95 percent for the year 1955, and 100 percent thereafter.

Section 247.-Dividends paid on certain preferred stock of public utilities

Under section 247 of H. R. 8300 a public utility is given a deduction for dividends paid on certain of its preferred stock. This deduction is the same as the credit for dividends paid on utility preferred stock now allowed under section 26 (h) of the 1939 code. Under section 275 of H. R. 8300, however, no deduction, otherwise allowable, will be allowed for any amount paid with respect to nonparticipating stock. Inasmuch as preferred stock described in section 247 is nonparticipating stock within the meaning of section 275, no deduction would be allowed for dividends paid on utility preferred stock under the new code; a result obviously not intended.

Section 247 (a) of H. R. 8300 should be amended by inserting before the words "In the case of a public utility," the words "Notwithstanding the provisions of section 275,".

Section 248-Capital stock issuance expense

Section 248 provides that certain organizational expenditures of a corporation may, at its election, be treated as deferred expenses and amortized over not less than the first 5 years of the corporation's existence.

The provision will continue to deny as a deduction from gross income, expenses of a corporation incident to the issuance of its capital stock, such as Securities and Exchange Commission filing fees; State corporate filing fees; State regulatory filing fees; Federal, State, and local taxes; legal, engineering, and accounting services; investment counsel fees; transfer agent and registrar fees; printing, engraving, advertising, selling, and other expenses in connection with issuance of capital stock.

It is common knowledge that large amounts of new money are required continually in the development and expansion of the gas industry. The recurring issuance of stock is thus a regular part of the gas business, and expenses associated therewith are just as much an ordinary and necessary expense as any other operating expense. It is equitable, therefore, that these expenses should be permitted as a deduction in the determination of the net income when they are such an integral part of the year-by-year operations of most gas companies. The proposed Internal Revenue Code of 1954 should be changed to permit an election to deduct currently or amortize the expense of each capital stock issue. Section 305-Distribution of stock and stock rights

The normal refinancing of a preferred stock often incorporates an offer of exchange of new preferred stock or new bonds for presently outstanding preferred stock or bonds, with the unexchanged stock or bond being redeemed pursuant to a call provision.

Section 305 (c) (1) (B) may treat these normal call provisions as options, with the result that they take the form of an exchange but are taxed to the holder as a redemption.

It is suggested that section 305 (c) (1) be clarified so that an option shall not be deemed to be held by a shareholder by reason of the presence or exercise of a call or redemption provision.

Section 309-Corporate distributions-Tax on transfers in redemption of nonparticipating stock

This section was inserted to prevent the withdrawal of earnings from a corporation at capital gain rates instead of at ordinary income rates. To the extent that it achieves its purpose, it is worthy of retention. It operates by levying a transfer tax at the rate of 85 percent on money and property paid out by the corporation in redemption of preferred stock, with certain exceptions. One of the exceptions provides, in effect, that if preferred stock was issued for securities or property, the transfer tax applies only to the money or property paid out in redemption which exceeds 105 percent of the value of the money or property paid in at the time the stock was issued.

Many preferred stocks which were issued for cash in public sales bear call prices in excess of 105 percent of the proceeds of sale. For instance, a list of 323 utility preferred stocks compiled by Spencer Trask & Co., a large brokerage firm, on June 15, 1953, includes 153 issues the call prices of which are in excess of 105. Many of the issues in this list were sold at competitive bidding. From time to time it is desirable for the issuing company to redeem these stocks. A frequent reason for such redemptions, particularly in the gas industry, is a change in the money market which makes possible the refunding of preferred stock with new preferred stock bearing a lower dividend rate. This type of transaction in a publicly held corporation is a legitimate business transaction in which tax avoidance is not a consideration. Under section 309, however, such a redemption at a call price in excess of 105 cannot be made prior to January 1, 1964, regardless of the date of issuance of the stock, without the transfer tax being applied to the proceeds of redemption in excess of 105.

The provisions relating to the redemption of nonparticipating stock should be changed to make clear that corporations whose ownership is as widely distributed as that of most public utilities can refinance or redeem their nonparticipating stock without being subjected to the severe penalty now proposed. Sections 331-336-Corporate liquidations

Under the present code, the merger or liquidation of a subsidiary into the parent corporation normally results in no income or loss to either the parent or the subsidiary corporation. Such a transaction is governed by section 112 (b) (6). Section 113 (a) (15) provides that the basis of the assets of the sub

sidiary in the hands of the parent shall be the same as in the hands of the subsidiary. Section 112 (b) (6) has no precise counterpart in H. R. 8300. All corporate liquidations are covered by new sections 331 through 336, inclusive. Whether or not a liquidation results in gain or loss to the shareholders of the liquidated corporation under section 331 would depend on the relationship to each other of the (1) fair market value of the assets distributed, (2) the adjusted basis of the assets distributed, and (3) the adjusted basis of the stock redeemed. The extent of such gain or loss, if any, and the basis of the assets in the hands of the distributee shareholder all would require that the fair market value of the assets distributed, both individually and in the aggregate, be ascertained.

The determination of fair market value of assets distributed presents particularly difficult problems for the gas industry. Most of the assets of a utility consist of specially designed plant and equipment required to furnish service to its customers. This plant and equipment has little if any commercial value other than for the purpose for which it was built. Hence, the determination of fair market value would present almost insurmountable problems to the utility, particularly where the earnings experience is less than a fair rate of return on the net investment in assets.

If the basis of assets received in liquidation as provided under section 334 is the fair market value of the assets at the time of distribution, the utility will be required to maintain different property records for tax and for regulatory purposes. This conflict arises from the requirements of regulatory authorities, such as the Federal Power Commission, that the utilities under their jurisdiction maintain their property records on a cost basis.

It is therefore urged that taxpayers be given an election to be governed by the existing sections 112 (b) (6) and 113 (a) (15) or by the new sections 331 to 336. Section 391-Effective date of subchapter C

Subchapter C of H. R. 8300 deals with corporate distributions and adjustments. As is stated on page 34 of the House committee report, “* * * your committee's bill represents a complete structural overhaul of existing law in this area." The provisions of this subchapter are made effective by section 391 to transfers or distributions occurring after March 1, 1954.

Because of the sweeping changes made and the complexity of the new provisions, taxpayers will need additional time to study and understand subchapter C. Moreover, it is inequitable to apply the changes in the law to the many pending transactions which were begun in good faith prior to March 1, but which have not yet been completed.

It is therefore recommended that the provisions of the proposed code affecting corporate distributions and adjustments not be applied to transfers and distributions occurring prior to January 1, 1955.

Section 461-General rule for taxable year of deduction

Section 461 (c) (1) of H. R. 8300 requires a taxpayer who reports income and deductions on the accrual basis to accrue real property taxes ratably over the period to which such taxes are related. Section 461 (c) (2) provides that the foregoing rule does not, however, apply to any real property tax to the extent that such tax was allowable as a deduction under the 1939 code for any taxable year beginning before January 1, 1954. The operation of these two provisions may result in considerable inequity to some accrual basis taxpayers for the year 1954. That inequity can be illustrated by the following situation. In most States and taxing subdivisions thereof, real property assessments are made on other than calendar-year bases. Under practice approved by the Commissioner of Internal Revenue for many years, an accrual-basis taxpayer may accrue real-property taxes as of the lien date, even though such taxes are for the succeeding taxable year. Hence, such taxpayers can accrue on their 1953 Federal income-tax returns real-estate taxes assessed during that year even though the tax so assessed is in fact attributable in whole or in part to 1954.

For example, under section 461 (c) (2) of H. R. 8300, an accrual-basis taxpayer who had accrued as of July 1, 1953, real-estate tax attributable to 1954 would thus be denied any deduction on his 1954 return for real-estate taxes. The reason for such a result is that the real-estate tax assessed as of July 1, 1954, could be deducted only in 1955 under H. R. 8300 inasmuch as such tax is attributable to that year. Unless, therefore, a deduction is allowed on the 1954 return for real-estate taxes, a heavy and inequitable penalty is inflicted on the taxpayer for 1954.

The elimination of such a penalty is clearly indicated, since Congress obviously did not intend such a result. It is suggested that the taxpayer be given an

election to continue the method heretofore consistently followed in accruing real-property taxes.

Section 481—Adjustments required by changes in method of accounting

Section 481 provides that "in computing the taxpayer's taxable income for any taxable year, if such computation is under a method of accounting different from the method under which the taxpayer's taxable income for the preceding year was computed, then there shall be taken into account those adjustments which are determined to be necessary solely by reason of the change in order to prevent amounts from being duplicated or entirely omitted."

On page A164 of the report of the Committee on Ways and Means of the House of Representatives, it is stated, "It is only those omissions or doubling ups which are due to the change in method which must be adjusted."

Such a provision, however, will apply inequitably to taxpayers whose accounting is prescribed by the Federal Power Commission and by the various State regulatory commissions.

For example, for some years natural gas companies subject to regulation by the Federal Power Commission or State public service commissions have been storing natural gas underground in depleted gas sands or other formations favorable for the storage of gas.

Under the uniform system of accounts prescribed for natural gas companies by the Federal Power Commission, it has been provided that the inventory of gas stored underground shall be priced at cost and that "transmission expenses for facilities used in moving the gas to the storage area and expenses of storage facilities shall not be included in the inventory of gas except as may be authorized by the Commission."

It is believed that this method meets the requirement of section 22 (c) of the 1939 code and section 471 of the proposed new code in that it conforms to the best accounting practice in the trade or business and most clearly reflects the income.

The Federal Power Commission has proposed a change of accounting practice in its docket R-130, in which the cost of transmission and storage would be added to the cost of the inventories of gas stored.

If the Federal Power Commission's proposed rule should be adopted, the Secretary or his delegate might consider the accounting change one that would authorize the application of section 481 and would make retroactive adjustments of inventories vastly exceeding the amount of such adjustments effected and recognized by the Federal Power Commission. For example, even though the Federal Power Commission's change would take effect with only the inventory increments in the current year, the Secretary or his delegate might undertake like adjustments for periods of years prior thereto.

To avoid this result, there should be a clear expression in the code that an accounting change instituted by a regulatory authority and in turn elected by the taxpayer or imposed by the Secretary or his delegate, shall have no greater retroactive effect than that created by the regulatory authority.

This may be accomplished by adding to subsection (b) of section 481 the following:

“(3) The change in the method of accounting is required by a regulatory authority having jurisdiction over the rates of the corporation, the adjustments taken into account under subsection (a) shall have no greater retroactive effect than that created by the regulatory authority."

Section 1341-Computation of tax where taxpayer restores substantial amount held under claim of right

Section 1341 provides for an alternative computation of tax where a taxpayer restores a substantial amount which was included in gross income for a prior taxable year because it appeared that the taxpayer had an unrestricted right to the item of income.

The section is specifically made inapplicable to sales of stock in trade or property of a kind properly includible in inventory. The report of the Committee on Ways and Means of the House of Representatives at page A294 indicates that the reason for this is that "an accrual basis taxpayer may instead estimate sales returns and guaranties in accordance with section 462."

Taxpayers subject to regulation are frequently in the position of collecting revenue during a period in which their rates are under review by a regulatory authority. As the result of the decision of the regulatory authority, they may be required to refund to their customers amounts included in gross income in a prior taxable year.