problems. He has presently no connection with the management of these trusts, and has not had for some 15 years. Mr. Channing is interested in H. R. 5418 only by virtue of his ownership as a fiduciary, mostly for persons of moderate means, of several substantial blocks of real estate trust shares. Mr. Channing is also a director of Minot Kendall & Co., Inc., a firm of stock brokers located in Boston, Mass., members of the Boston Stock Exchange and of NASDI, and is hence familiar with the market for these shares from a broker's viewpoint. Mr. Channing has been a director of a number of business corporations, and has held positions of substantial public responsibility, including having served with counsel to the War Industries Board in the First World War.

2. Economic and social justification of real-estate trusts

At the turn of the century there were a number of attorneys practicing in Boston who had great familiarity with real estate conveyancing and probate law, and who handled the property and affairs of a considerable clientele of persons of means. Real estate and interests therein were then a traditional medium of fiduciary trust investment. But at the time referred to, with an almost phenomenal growth taking place in our country, particularly in the West, parcels of commercial property, and the buildings thereon, were rapidly becoming far too expensive and large for individual investment consistent with proper diversification and limitation of risk.

The real-estate trust was conceived and thought of as a medium of common investment in the improvement of real estate by persons of moderate means investing conservatively, but investing at the same time with a view to gradual growth in the value of their holdings. These entities were set up as trusts partly because their founders thought in trust terms as probate lawyers. Their financing was a model of conservative soundness, being (as far as we know) entirely in common shares, and usually with a limitation on the trustees' power to mortgage the properties purchased for more than a percentage (30 percent for example) of the par value of the shares. Thus, the attractiveness of the shares was not at all in "leverage"-the mercurial reaction of a narrow equity over a large debt-which modern taxation has made so deceptively attractivebut in the soundness of a picture unembarrassed by debt and managed by persons combining the caution of the experienced fiduciary with the imagination necessary to conceive of growing communities in distant places. The type of persons who subscribed to the shares justified the plans and the intentions of the promoters. Shares were not bought to be traded or sold for quick profit, but to be held for income and growth. Thus was created a flexible yet stable medium whereby persons of ordinary means could own interests in diversified real estate. Tens of millions of dollars were invested in these trusts, and capital flowed out from Boston not only through New England, but into communities as far west as Seattle and as far south as Alabama and was heavily invested in growing cities like Detroit, St. Paul, Kansas City, and Denver, to mention examples. While the original investments were of Boston capital, there is no formal limitation in that regard, and today shares are owned by persons in many different States. That this was all in the national interest hardly is worth debating. 3. Effect of Federal corporate income taxation on real estate trusts

The last real estate trust designed for public ownership, of which the author is aware, was formed in 1937. Since that time, the corporate income tax, as it has increased, has gradually destroyed the market for these shares, and by destroying that market will, in the writer's opinion, gradually strangle the trusts themselves. Because, as will be explained, the corporate income tax does not destroy the market for the real estate the trusts own, the shareholders will not suffer, but in the liquidation of that real estate in winding up the trusts a medium will be lost which could do a great deal to ward off depression by encouraging the small man to invest in real property. What has happened to real estate trust shares, and what will happen if H. R. 5418 fails of passage, is simply an example of the unintended but nonetheless fatal economic consequences of legislation designed only for revenue purposes, and the following is a sketch of how it operates in this case.

Income producing shares on the stock market will usually sell on a "times earnings" or more accurately "times dividend" basis, which varies as between stocks of different categories, and varies with money rates over a period of time. If you have two categories of owners, one who by virtue of some rule of law or device derives twice as much income from a property as another, it will be worth twice as much to him. Thus, a typical real estate trust share paying a $7

dividend might sell for $100 on today's market. But, before Uncle Sam got his 52-percent cut, who will buy on the basis of the same yield of 7 percent, you will find a man who will pay on the basis not of $100, but of much more. And, in the case of real estate, that is exactly what you do find. For every parcel of commercial real estate, there is a wealthy speculator or syndicate who, because they act individually, are exempt from the 52-percent corporate tax.

Since credit has been easy, and since for a wealthy man the income-tax law cuts interest charges in half or better, what could be more attractive than paying on a basis to yield 7 or 8 percent for a narrow equity in the property we have described? Thus, the small man, in paying 50 percent of income for diversification and limited liability, cannot compete with the large. Thus the trustees of these real-estate trusts, who are acting entirely for the small man, cannot compete for properties with the tax free individual-nor can they interest capital for a 3 to 4 percent yield, which is the yield on sound corporate bonds. Because of a general realization that real-estate trusts were going nowhere in particular and could go nowhere in particular as they have been taxed, the investing public has gradually turned away from them. Thirty years ago, trust companies and trustees of large charities and universities would buy these shares for investment, which they would not consider today. At the tag end of the depression and into the postwar era, the shares of some trusts became bait for big speculators. At least one fortune was made through buying shares cheap on the depressed market for shares, and compelling liquidation of the trust on the much higher market for real estate. The share market today has become largely restricted to the managers of the trusts and interests they control. When sold to the public these shares are never sold without reference to a possible profitable liquidation. Meanwhile, insurance companies have grown, and investment trusts have grown, only because insurance companies are subject to entirely different taxation when investing, and investment trusts to no corporate taxation at all (when complying with certain legal requirements). If tomorrow investment trusts were subjected to income taxation at 50 percent, they would experience exactly what real-estate trusts have—a constriction of the market for their shares, and inevitable slow extinction. Because the stockholders would sell on the basis of the full market to persons free of tax they would not suffer; only the medium of common investment would be lost, with inevitable social damage.

4. Effect of H. R. 5418 in stimulating investment in real estate

No one can assess the future, but anyone is a fool to fail to provide for its obvious dangers. The country stands now at the end of a long extraordinary effort that began with Pearl Harbor. Everyone remembers and bears the scars of 1929 and the depression which ensued. Everyone recognizes the necessity to stimulate the economy in this year 1954. Everyone recognizes further that at the basis of the economy the construction industry lies as an important cornerstone. There is today no recognized medium for investment by which the weight of public interest and widely held funds can be brought to bear in this field, because the tax law keeps the field confined to the big individual or the special purpose corporation, usually a tool of some other interest and always loaded to the gunwales with debt. At the same time our population is increasing. Even more important immediately it is decentralizing. The revolution the automobile made possible is just beginning its ultimate momentum. Now our industrial and commercial cities are beginning, and just beginning, to indicate their future shape-covering areas many times the present size, linked by superhighways, supported by garden cities where people work and live as they were meant to, and not in the rabbit warrens the industrial revolution brought into being. To implement and carry out this great change, vast resources will be needed, and H. R. 5418 removes an impassable obstacle to another economic revolution such as the model T so largely brought about. It should be borne in mind its effect is not limited to Massachusetts organizations; similar entities can be and would be formed anywhere, depending only on the particular provisions of local laws.

5. Arguments against the bill are invalid

1. It has been said that the bill gives the stockholders a windfall. Western Real Estate Trustees for example was started in about 1900, and capital was subscribed at $100 per share. The market value of shares today is about $100. It has been reliably estimated that if the underlying properties were sold today they would bring around $170. It is submitted that taking the decline of the value of the dollar into account that is no "windfall." But if it is the passage or nonpassage

of this bill has nothing to do with a liquidation at $170. If it is this "windfall" which is to be prevented, legislation should prevent not only liquidation, but merger with an investment trust as well.

2. It has been argued that these entities are too narrowly held to be regarded as public. It is true the tax has narrowed the holdings. It is also true that these trusts are as widely held today as investment trusts once were, and it must be apparent they will grow if given a fair chance to do so, and that many new ones could be expected to spring up.

3. It has been argued that by this legislation revenue will be lost. This is not so. Because the trusts are being driven to liquidate or become investment trusts the revenue will be lost in any event. Repeal of taxation in this instance will lead to much larger revenues to all sorts of persons and businesses subject to tax, precisely as happened with investment trusts.

Respectfully submitted

APRIL 19, 1954.

HENRY M. CHANNING.
By his attorneys:

LAURENCE M. CHANNING.
FRANK S. KETCHAM.

Mr. HIGGINS. This is a very serious situation. I believe these trusts would have gotten the same benefits and treatment as the security-investment trusts had they come in in 1936 and 1940, when those were corrected, but at that time most of the real estate investment trusts had very little income and the impact of the corporate tax didn't force them into it. As it is now, it has become so serious that this very substantial source of investment money in real estate is going to dry up.

Now, conversely, if this provision were included, we believe that you might get a tremendous lift in real-estate investment, as has occurred in the case of the security-investment trust. I well remember when I was before your committee in 1936 and 1941, that there was grave doubt as to whether it wasn't going to cost a tremendous amount of revenue. The reverse situation occurred, namely, that a great many small investors all over the country who hadn't before invested in stocks and bonds, took up this idea of the security investment trust, with the result that there has been a very substantial increase in revenue, rather than a decrease.

Now, we believe that in this economic period, if we could get the same relief for the real-estate investment trusts, you would get that same effect of many thousands of beneficiaries all over the country putting in funds to invest in and build new buildings throughout the country.

Thank you.

The CHAIRMAN. Thank you very much.

Senator FLANDERS. Might I ask a question?

The CHAIRMAN. Certainly.

Senator FLANDERS. I would like to inquire about the size of this operation. I must confess that it was something of which I had no knowledge until you came to the committee with these suggestions. Are there many who invest in real-estate investment trusts? Do their total investments aggregate to a considerable amount?

Mr. HIGGINS. Well, I know, Senator, of about 25 or 30 of these trusts and there are undoubtedly more that I haven't heard of-I would say that more than 50 percent of them are located in New England, but there are a good many I hear about as a result of previous

appearance before the Ways and Means Committee, in other parts of the country.

It would be very difficult for me to make an estimate as to their total assets, but I would say that it runs into probably several-maybe $125 million or $130 million at least, maybe more. I know the security trusts were very small when they first got their relief, and have gone up 3,000 or 4,000 percent since then.

As to shareholders, I believe from figures I have been able to corral around New England, that there are at least 5,000 to 7,000 shareholders in that area alone, and probably an equivalent number outside. Senator FLANDERS. Thank you.

The CHAIRMAN. Thank you very much.

(The detailed statement referred to on p. 1276 follows:)

DETAILED WRITTEN STATEMENT OF ALLAN H. W. HIGGINS IN SUPPORT OF INCLUSION OF PROVISIONS OF H. R. 5418 IN H. R. 8300, AN ACT TO PROVIDE FOR A SPECIAL METHOD OF TAXATION OF REAL ESTATE INVESTMENT TRUSTS AND REAL ESTATE INVESTMENT ASSOCIATIONS WITH TRANSFERABLE SHARES, OR BENEFICIAL INTERESTS IN SUBSTANTIALLY THE SAME MANNER AS SECURITY INVESTMENT TRUSTS This bill was introduced by Representative Goodwin on May 27, 1953. Witnesses appeared before the Ways and Means Committee on August 6, 1953, and testified at length in support of the bill. (See Hearings on General Revenue Revision, pt. 3, pp. 1496-1505.) Due to pressure of time, the bill was not brought to a vote in the committee, or in the House, but was held for further consideration. The bill has been amended to provide additional limitations and safeguards, which were not in the bill as introduced but appear in the form of the first bill attached hereto, as the result of conferences with representatives of the Treasury Department and the joint committees. Also is attached a revised form of the bill to integrate it as part II, subchapter M, subtitle A of H. R. 8300.

I. SUMMARY OF THE PROVISIONS OF THE BILL

1. Provides for a new supplement V in the present Internal Revenue Code (or pt. II of subchapter M, subtitle A of H. R. 8300), covering the taxation of real estate trusts and associations with transferable shares or beneficial interests. 2. Provides that real estate investment trusts be granted the same relief from corporate tax as is now given to security investment trusts under supplement Q (secs. 361, 362) of the present Internal Revenue Code. It accomplishes this result by providing that real estate trusts and associations, which meet certain conditions, shall receive a dividends paid credit in computing the net income subject to tax at corporate rates.

3. Provides that such a trust or association can qualify for the credit under 2 supra, only if—

(a) At least 90 percent of its gross income is derived from dividends, interest, rents of real estate, and gains from the sale of real estate.

(b) At least 60 percent of its gross income is derived from rents of real estate, interest on real estate mortgages, gains from the sale or other disposition of real estate or similar income derived directly or indirectly from real estate.

(c) Less than 30 percent of the gross income comprises net gain from the sale or other disposition of securities held for less than 6 months.

(d) Less than 30 percent of its gross income comprises net gain from the sale of real estate held for less than 5 years.

(e) Ninety percent or more of its net income is distributed to the share holders or beneficiaries each year, computed without regard to net long-term or short-term capital gains.

1. Purpose of the bill

II. STATEMENT IN SUPPORT OF THE BILL

The purpose of H. R. 5418 is to relieve an inequity and unjustifiable hardship under the Internal Revnue Code with respect to imposition of a corporate tax on small investors or beneficiaries who have pooled their funds and interests

in order to secure or maintain investments in real estate or interests in real estate, including real estate mortgages, and shares of real estate trusts or real estate associations.

2. Real estate investment trusts should be taxed in the same manner as security investment trusts

Under supplement Q (sec. 361 and 362) of the Internal Revenue Code, regulated investment companies, i. e., security investment trusts are relieved from a Federal corporate income tax, provided they meet certain conditions, and especially if they distribute during the taxable year to their shareholders as taxable dividends, other than capital gain dividends, an amount not less than 90 percent of their net income for the taxable year.

On the other hand, real estate investment trusts have, in recent years, by judicial decision been subjected to a Federal corporate income tax. The imposition of a corporate income tax on such real estate trusts is especially unfair, when it is considered that the purpose of such trusts is principally to hold investment real estate, as well as securities, provide unified management, and distribute substantially all their income to their beneficiaries or shareholders annually, just as security investment trusts do. In this respect the trusts are, in fact, conduits of income, just as are stock investment trusts, whose unique status has been specially recognized under the Internal Revenue Code.

The proposed act attached hereto would grant substantially the same treatment to real investment estate trusts as is now given to security investment trusts under the Internal Revenue Code. This would be accomplished either by inserting a new supplement in the present code, to be known as supplement V, or by adding equivalent provisions as part II of subchapter M of subtitle A of H. R. 8300. Such similar treatment of the two types of trust is not only fair and equitable, it is also completely justified when their purposes and operations are analyzed.

The justification for granting special treatment to security investment trusts under supplement Q was that such trusts permitted a group of investors to pool their funds and obtain competent management of their investments, diversification, and the minimizing of risks. These objectives would not be obtainable to such investors if, with their limited capita, they tried to invest directly in stocks and bonds for themselves.

The proposed act would grant the same privilege to a group of investors who pool their funds to invest in rental real estate by means of a real estate investment trust.

3. The conduit theory should be applied to all investment trusts to eliminate double and triple taxes

Relief from the corporate tax was given to security investment trusts on the theory that they were substantially conduits of income, and that the investment income should not be subjected to double taxation, by first having the income subjected to a Federal corporate income tax in the hands of the trust and then by having the distributions from the trust received by the beneficiaries or shareholders taxed again.

In the case of stocks held by security investment trusts, it was argued that there had been a triple tax, namely: First, a tax on the corporation that issued the stock and paid the dividends thereon, next a tax on the dividends received, and lastly a tax on the distribution by the trust to its shareholders. It should be noted, however, that the alleged second tax was only on 15 percent of the dividends received by the trustee.

In the case of bonds held by security trusts, there was at most only a double tax, in that the corporation paying interest, although it had paid a corporate tax, received a deduction for the interest paid. Nevertheless, the so-called bond funds or bond investment trusts were given the same relief from corporate tax, as were the stock investment trusts.

In the case of the real estate investment trust, the rent received by such trust is completely analagous to the interest received by the bond investment trust. In the one case the paying company is paying interest for the use of money and in the other case it is paying rent for the use of property. In both cases the payor corporation, whether paying interest or rent, is nevertheless subjected to tax on its business income. The source of the income of real estate trusts is principally rents from commercial real estate occupied by business tenants. An income tax burden falls first on the business of the tenant, second on the real estate trust, and finally on the distribution by the trust to its beneficiary.