tions of closely held corporations as well as of publicly held corporations, and have validated reorganizations where property or stock of one corporation is acquired by another corporation solely for voting stock, whether common or preferred. Ample safeguards have been established by Supreme Court decisions by the establishment of the business purpose and continuity-of-interest tests, among others, to assure that reorganization provisions are not used for tax-avoidance purposes. In the absence of a convincing showing in the committee report as to the need for this change in philosophy, we submit that the substance of the old provisions should be retained.

Under the new bill a merger or consolidation by a parent corporation listed on a stock exchange and publicly held with its controlled subsidiary would not be tax-free. We disagree with this and we suggest that this provision be modified by amendment to section 311 or to section 359 permitting the tax-free merger or consolidation of a publicly held corporation with a subsidiary of which it owns more than 50 percent of the stock.

To sum up: It is our view (1) that the existing reorganization provisions should remain in effect until January 1, 1955; (2) that subchapter C as proposed in H. R. 8300 should be amended to eliminate the limitation of tax-free mergers and consolidations to publicly held corporations; (3) that the requirement be eliminated that the stockholders of the acquired corporation end up with at least 20 percent of the participating stock of the acquiring corporation and in this respect to retain instead the substance of present law; (4) that taxfree merger or consolidation of a publicly held corporation, if that concept is retained, be permitted with another corporation which it controls by ownership of more than 50 percent of the stock; and (5) that the tax in the case of preferred-stock bailouts be imposed at the stockholder level and not on the corporation.

STATEMENT OF J. S. SEIDMAN, AMERICAN INSTITUTE OF
ACCOUNTANTS

Mr. SEIDMAN. My name is J. S. Seidman. I appear as general chairman of the Committee on Federal Taxation of the American Institute of Accountants. I am accompanied by our subcommittee chairmen, Wallace M. Jensen, Leslie Mills, and J. P. Goedert.

The American Institute of Accountants is the national organization of certified public accountants, with a membership of over 23,000, The institute appreciates your willingness to hear it.

Our own tax committee, composed of over 30 CPA's from all over the country, and whose life's work is taxes, has been engaged in intensive study of H. R. 8300 since the bill was released a month ago. But we can hardly lay claim to understanding all its provisions, no less mastering them. That is particularly true of the area from which business draws so much of its daily lifeblood-corporate and partnership organizations, distributions, liquidations, and reorganizations.

The fact that we, who should be well informed, find ourselves reeling is significant. It leads to our first suggestion: Hold off the appli

cation of these provisions at least until 1955, or 90 days after the bill is enacted, whichever is later.

Effective date for corporate and partnership provisions: Having waited 73 years for a thorough overhauling of our tax statutes, it is not asking too much to indulge a few more months. No revenue gain or loss is attributed to the corporate and partnership provisions. On the other hand, look how much good can be accomplished by holding off:

(1) It will give everybody a better opportunity to become acquainted with the rules of the game before getting on the ball field. This is as it should be, if injury or chaos is to be avoided. At best, the bill is not likely to be enacted before June. Assuming that the Senate does not rubberstamp the House bill and vice versa, taxpayers have no way of knowing yet what to count on. To drastically change the rules in the middle of the fourth inning, not only for the rest of the game but also for the innings already played, is hardly likely to sit well, either for the game, the players, or the rulemakers. No; it is far better to let the game be completed and apply the new rules the next time around.

(2) We can tell you that there are all sorts of "bugs" in the present provisions of the bill. We have just concluded what, to us, was a very delightful and constructive screening with Mr. Stam and his colleagues, of 213 changes we are recommending to you-in extension of this testimony-in the income-tax part of the bill. Over 90 apply to the corporation and partnership sections. I think it is fair to say that your technical experts felt that many of these recommendations merit consideration.

(3) From the time the bill is passed to the end of the year everyone concerned will have some opportunity not only to prepare for the new rules but also to appraise them. We have a feeling that the respite will prove a godsend in bringing to light and paving the way for advance correction of things that might otherwise provoke incalculable mischief in the daily affairs of business. At the very least, it will parole those who have already been caught in the trap and those yet to be trapped, and whose only crime is that they did not have a decent chance to know or be advised about the new, drastically changed and complex code.

Loopholes: The bill attacks loopholes on a broad front. That is commendable. Loopholes impair taxpayer morale and enable one taxpayer to get out from under the intended share of his tax burden, and palm it off on the rest. Loopholes sometimes mount to a point where they come back to roost at the doorstep of Congress, as ìllustrated by the special hearings necessitated in 1937 tax avoidance. Every effort should be exerted to squelch loopholes before they rear their ugly heads. We fear that in the process of closing some doors, this bill unwittingly opens many others. We are sure we have not uncovered them all, but our recommendations that we are filing with you, refer to over 25 loopholes cutting clear across the bill. I will mention a few here:

(1) Under the spin-off provisions, section 353, the floodgates will open pretty wide. From 1923 to 1951, spin-offs were fully taxed. In 1951, limited exemption was accorded them. Now, it will be possible to segregate tax-free investments, real estate, and even cash, into a

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separate company, and, by exercising 10 years' patience, get the cash and the other items into the stockholders' hands as a capital gain instead of an ordinary dividend.

(2) The right to a deduction for premium on bonds with early call dates has developed into a nasty loophole. But the solution in the bill, section 171, is like attacking a battleship with a B-B gun. All the bill does is to set up a 3-year barrier. That is hardly a deterrent to those hellbent for tax saving. We suggest that bond premiums be spread from the date the bond is bought to the date of maturity. If a bond is actually called before maturity, the part of the premium not yet deducted can then be allowed in full. That accords with good accounting. We think it makes for good taxes.

(3) The dividend credit-which we favor-can lend itself to abuse, section 34. A taxpayer with short-term profits will find it to his advantage to buy stock just before the dividend is paid, and sell it right afterward. This will enable him to reduce the tax on his shortterm gains by the dividend credit. A possible solution is to condition the credit on a prescribed holding period before and after the stock goes ex-dividend.

(4) A capital loss can become a regular loss, and vice versa, under the way the foreclosure provisions, section 1035, are treated in the bill. For example, suppose $20,000 is owing the taxpayer for the sale of merchandise. He forecloses on securities that he holds as collateral. The securities are worth $19,000 at the time. Two years later, the securities have declined in value to $8,000, and he then sells out. Under the bill, he gets a $12,000 ordinary loss because the account receivable was from a merchandise transaction. Obviously, however, his loss on the account receivable was only $1,000 and the other $11,000 came from speculating in the securities.

(5) Subordinated debt issued to corporate insiders is treated in the bill as stock, and interest on it is not deductible, section 275. Redemption of this type of debt can, therefore, be a dividend. But look how easy it is to get around it: Subordinated debt is issued to the insider as a dividend. Since the debt is loooked upon as stock, that would be a nontaxable stock dividend. The insider then sells the debt to an outsider. That gives capital gain to the insider. In the hands of the outsider, the subordinated debt becomes real debt. The interest is then deductible to the corporation. The retirement of the debt is no longer a dividend, and everybody is happy but the Treasury. Taxing the wrong taxpayer: In shooting at some loopholes, the bill put the wrong taxpayer in the line of fire. Here are some illustrations of what we mean:

has

(1) The death sentence is given to the "bailout" of redemption of preferred stock issued as a dividend, through an 85-percent tax on the corporation, section 309. The punishment doesn't fit the crime. What should be aimed at is to tax the insider, as a dividend, for the amount he gets out of the company through the redemption. To tax the corporation makes the minority stockholders pay through the nose for something that they didn't participate in, and have no control over.

(2) If a partner retires, and under the partnership agreement he continues to have an interest in the income of the firm, payments to him from the partnership profits for the ensuing 5 years are, under the bill, taxable to him and not taxable to the continuing partners, section 336 (a). So far so good. However, payments after the 5-year

period are not taxable to the retiring partner but are taxable to the continuing partners. So far, not so good. The underlying inference is that after 5 years the retiring partner is getting a gift from the continuing partners. There may possibly be some room to impute gift if we are dealing with a family partnership, but among strangers, dealing at arm's length, letting one partner go scot free and taxing his income to other partners, just flies in the face of the facts.

(3) One of the many unfortunate and costly loopholes in the existing law is the traffic made possible in loss companies. Whatever else may become the effective date of the pending bill, this loophole should be closed immediately. The mechanics sought to do so in the bill is to amputate the net loss carry forward on a pro rata basis to the extent that there has been a shift in stockholdings of more than 50 percent. Again, the perfectly innocent continuing minority stockholder is called upon to bear the brunt of a transaction over which he has absolutely no control. Incidentally, the loophole closing does not go far enough, in that only the net loss of previous years is extinguished. The net loss of the current year is not touched and, therefore, continues to make valuable traffic.

The vanishing basis: In income-tax law, the word basis is generally a substitute for the word cost. The bill properly speaks of adjusted basis, substituted basis, and apportioned basis. But it also introduced a bit of legerdemain that I will call the vanishing basis. As a result, honest-to-goodness cost incurred in acquiring an asset goes up the flue. To that extent, what is taxed as income in really capital. That is not sound. Some examples may be helpful.

(1) Suppose a stockholder owns common stock costing him $100 and preferred stock costing him $200. The preferred stock is redeemed by the company for $200 under circumstances that make the whole $200 taxable as a dividend, section 302 (b). What happens to the $200 cost of the preferred stock? Under the bill, it just disappears. It should really be added to the taxpayer's cost of common stock. No provision is made for this.

(2) The same thing can happen in a corporate liquidation. Suppose a 100-percent stockholder paid $100 for all the stock of a company. The only asset of the company is inventory that cost the company $75 but is worth $100. The company liquidates. Under the bill the stockholder takes the inventory over at $75, its cost to the company. However, he is not allowed any loss. That leaves his other $25 of cost suspended in midair with no place to go or be used.

(3) Take the situation where Company A spinsoff Company B. The sole stockholder of Company A then splits the cost of his stock in Company A to $100 for A and $50 for B. Within 10 years he cashès in on his stock in Company B, with the result that the sales proceeds are all taxed to him as a dividend, section 353 (b). The $50 cost of his stock in B disappears. A fair arrangement would permit him to add the $50 to his cost in Company A, or, if he no longer has Company A stock either, he should be permitted a capital loss of the $50. Impact on fiscal years: The Internal Revenue Service, business groups, and our own accounting profession have been urging taxpayers to keep their accounts and make their tax returns on a natural business year, if this differs from the calendar year. However, no tax advantage or disadvantage should derive from the fortuitous circum

stance of the date of closing the books. This principle is violated in the bill. Let me mention a few of the instances:

(1) The bill introduced a 2-year carryback on net losses compared with the present 1 year. If a company on a calendar-year basis has a loss in 1954, that loss can apply against its income in 1952. However, if the company is on a November 30 fiscal year, none of the loss during 11 months of 1954 can be applied against 1952. The 2-year carryback will apply only to losses starting after November 30, 1954.

The CHAIRMAN. Is that right?

Mr. SMITH. Yes.

Mr. SEIDMAN. This should be corrected. The pattern for correction is the one previous revenue acts have followed, namely, a pro rata computation under the old law and the new, based on the number of months in 1953 and in 1954.

(2) The same point arises in respect, among others, to the allowance or deferment of research and experimental expenses, section 174; the new deduction for organization expenses, section 248 (c); the new right to defer prepaid income, section 452; and the new allowance of reserves for estimated expenses, section 462.

The right of a business organization to start off with a fiscal year of its own free choice should not be impeded. The bill runs afoul of that principle in respect to partnerships in section 706 (b) (1). For the first time in tax history, it prescribes that a new partneship must get permission to use a fiscal year. The Internal Revenue Service has, after its abundant experience over the years, come to the conclusion that greater elasticity rather than less is desirable in connection with the use of fiscal years. It therefore has given all taxpayers, including partnerships, the right to change from calendar year to fiscal year by their own say-so under certain circumstances. The provision in the bill stifling the use of fiscal years for new partnerships is a throwback that we hope your committee will remove.

Accounting provisions: The bill makes great strides in the direction of putting business accounting and income tax accounting on the same wavelength. That is something we have urged upon the Congress for many years. We applaud H. R. 8300 for getting it underway. The transition will bring on some problems, both from a revenue standpoint, as well as the scope of reserves for estimated expenses. For that reason, there is included in our list of recommendations certain cautions and restraints during the gear-shifting period. Other provisions: As previously mentioned, our recommendations for change No. 213. These cover almost the entire gamut of the income tax and administrative provisions. They include 5 on dividend credit, 6 on depreciation, 17 on accounting, 14 on capital gains and losses, 11 on consolidated returns, 13 on administration. I'll single out a few that may interest you here:

(1) The date of mailing a return should be considered as its filing date.

(2) Capital losses should, like operating losses, be allowed a 2-year carryback, in addition to the present 5-year carryforward.

(3) The maximum tax on long-term capital gains should be 25 percent of the net taxable income, and not 25 percent of the net longterm gains, where the ordinary deductions exceed the ordinary income. At present, the net ordinary deductions can go to waste.