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present provision makes possible manipulation through the deliberate distribution of partnership property that has depreciated in value in order to get a markup for the partnership on property that has appreciated in value and is about to be sold. If the 1939 provision is restored, the problem of valuation and allocation that then arose can be obviated by using as the ratio the basis to the partnership of the assets distributed, compared with the basis of all assets of the partnership. (This will correspondingly affect secs. 732 and 733.)

166. Section 736 (a): 1. The limitations with reference to the number of years should be removed as the result it produces is completely unrealistic.

2. In any event, the limitations should not apply to a partnership where capital is not a material income-producing factor.

3. On the other hand, recognition should be accorded to the right of the partnership and the individual to enter into a contractual relationship after the retirement, as long as the status of the individual is other than as a partner.

167. Section 736 (a): If any payments are not to be deductible by the continuing partners, the payments should increase the basis of their interest in the partnership. Conversely, the amount received by the former partner should be considered as an addition to the sales price of his partnership interest.

168. Section 742: The exclusion under section 751 should be a reduction of the basis of a partner's interest or else there will be a double benefit. The increase in the distributive share of the partner's profit adds to his basis. Unless the exclusion serves as a reduction of the distributive share, it should serve as a reduction of the basis in the partnership. Another way of handling this adjustment is through section 751 (b) (1), where the exclusion is allowed. The exclusion could there specifically be labeled as a decrease in the partner's distributive share of the partnership profit.

169. Section 743 (c) (1): No further allocation of basis should be permitted to inventory. In addition, if the allocations are to be made in proportion to the adjusted bases of the assets, it will mean that there cannot be any allocation to goodwill and it will also mean a disproportionately low allocation to assets with a low base but a high market value. The criterion for allocation should therefore be in all instances fair market value of the assets involved.

170. Section 743 (d): There should be an election each year to adjust the basis of partnership property in respect to transfers that took place during that year.

171. Section 761 (a): It should be made clear that the ownership of real estate as tenants in common is not a partnership where the real estate is held for rental, investment, or sale.

172. Section 901: The foreign tax credit should be carried back and forward to prevent it from being lost completely in cases where the domestic parent has a loss in the year in which the foreign dividend is received.

173. Section 951 (a): The definition of a “branch” in a foreign country should be extended to include wholesale establishments. (This correspondingly applies to secs. 951 (b) (1) (A) and 923 (a) (3) (A) (ii).)

174. Section 1035: On a foreclosure the value of the property acquired in the foreclosure should be applied against the debt. The tax consequences as to the balance of the debt should be dependent upon the circumstances at the time. The status for capital asset purposes of the property acquired in the foreclosure should be dependent upon its own characteristics, just as if the property had been independently purchased by the taxpayer.

175. Section 1201 : The alternative tax should not be in excess of 25 percent of the amount of the net taxable income. (This would correspond in a way to the restriction on the dividend credit to 85 percent of the net corporate taxable income.)

176. Section 1211 (b): Income from the discharge of indebtedness should be reduced by any capital loss incurred in connection with the liquidation of the indebtedness, as in the case of the sale of collateral against the indebtedness.

177. Section 1212: A 2-year carryback for capital losses should be allowed just as in the case of net operating losses.

178. Section 1221 (4): Clarification is needed as to the reference to section 1035. That section refers to the capital-gain section and the capital-gain section in turn refers to section 1035.

179. Section 1221 (4): The provision excluding notes and accounts receivable from the status of capital assets should be extended to exclude all accounts and notes receivable to the extent that their receipt did, or their collections would, depending on the method of accounting employed by the taxpayer, constitute an item of ordinary income.

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180. Section 1231: Gain or loss on property used in the trade or business, etc., should be treated uniformly as ordinary income or loss.

181. Section 1232 (a) (1): To close the loophole on retirement of discount bonds during 1954, reference to January 1, 1955, should be changed to January 1, 1954.

182. Section 1232 (a) (2) (A): To shorten the period when the loophole on sale or exchange of discount bonds is possible, the reference to December 31, 1954, should be changed to February 28, 1954.

183. Section 1232 (a) (2) (A): Eliminate the complications that attend upon the ratio calculations. Instead, the entire original discount on the bond should be deemed recovered to the extent of the gain involved in the transaction. On the other hand, no ordinary income shall be applicable in any situation where the cost of the bond is in excess of the price to be collected at maturity or any earlier call date.

184. Section 1232 (b) (1): The reference to one-tenth of 1 percent of the redemption price at maturity should be changed to one-fifth of 1 percent in order to eliminate dealing with insignificant amounts.

185. Section 1232 (b) (1): In addition to the reference to the redemption price at maturity there should also be added reference to the earliest call price.

186. Section 1234: Page A279 of the Ways and Means Committee report indicates that a loss on an option to buy a residence would be deductible as a capital loss. Is that intended ?

187. Section 1237: No inference of non-capital-asset status should attach to holdings of real property for less than 5 years. They should be dependent upon a showing of the facts. (This same principle should apply to sec. 1238.) In any event, both sections 1237 and 1238 should include corporations. If both these sections are to stand, the restriction on improvements should be eliminated.

188. Section 1238 (b) (1): If this section (as to real property subdivided for sale) stands, then the sale of the first five lots should be regarded as sales of capital assets, regardless of when the sale of the sixth lot taxes place.

189. Section 1501 : The inclusion in the code of the previous regulations on consolidated returns is undesirable. It creates an inflexibility that does not now exist. It also means that in any change of the basic law, revision will have to be made, right then, in any related provision in the law affecting consolidated returns, whereas experience with the regulations has shown that it takes considerable time adequately to work this out.

190. Section 1501 : The requirement that the consent of all members of an affiliate be obtained would prevent the filing of a consolidated return where a sub-, sidiary which was at least 80 percent but less than 95 percent owned was sold prior to the time H. R. 8300 was introduced and where the common parent corporation at the time of sale failed to obtain consent of such subsidiary. This inequity should be removed.

191. Section 1505 (a) (2): The election to file consolidated returns should be available annually.

192. Section 1505 (a) (2): If no annual election as to consolidated returns is permitted, then the election should be made to apply to the taxable year affected by a change in law, irrespective of the filing of a prior year's return before or after the date the change is effected or enacted.

193. Section 1505 (a) (2): The word “substantially” should be eliminated since it is an unnecessary extension of the present regulations.

194. Section 1514 (a): The 2-percent additional surtax on income reported on a consolidated return should be eliminated.

195. Section 1524. The provision in parentheses in section 1524 (1) should also appear in section 1524 (2) with the same wording.

196. Section 1623: The consolidated-return requirement set forth in the last sentence should be eliminated so that the general limitation would also be inapplicable to an 80-percent owned subsidiary which filed separate returns for prior periods.

197. Section 1629 : If an affiliated group is formed or augmented after enactment various deductions otherwise applicable are restricted. The restrictions on the utilization of deductions should be limited to those cases in which utilization would constitute an abuse of consolidated returns. The qualification immediately following subsection (2) (D) should be extended to subsection (1).

198. Section 1707 (c) (2): It should be made clear that the principles of section 334 (c) apply where the stock of a corporation is really acquired as a

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mere step in a plan to acquire its assets and the corporation is liquidated forthwith. Since the liquidation of such a corporation might not be completed within 30 days, a reasonable period of time, such as 6 months, should be specified. Unless this were the case, it appears that the subsidiary would be required to join in making the consolidated return and that upon liquidation the basis of the property would be the same as it would be in the hands of the transferor.

199. Section 1708 (b): No adjustment of the opening inventory should be required in the first year a consolidated return is filed. As presently stated the rules permit either double taxation or double deduction which may not be adequately cured in the final consolidated return year.

200. Section 1732: The section as now written should be eliminated or it should be amended to permit allocation by agreement among the members of the consolidated group. It should be provided that, in the absence of such agreement, the allocation should be according to regulations to be prescribed by the Secretary or his delegate.

201. Section 6042: The requirements in section 147 (d) of the 1939 code for information returns on income payments to others should be restored. They should provide a valuable audit mechanism.

202. Section 6046: This section, relating to filing of reports hy advisers as to foreign corporations, should be eliminated as experience has demonstrated its impracticability. At the very most the return should be required only if the formation or reorganization is consummated.

203. Section 6071: There are several provisions in the law that will apply to fiscal years that closed in 1954 before the date of enactment. In many of those cases returns for those fiscal years will have already been filed. Those taxpayers should be required to refile their returns at the same time as returns due by calendar year 1954 taxpayers. Refunds and deficiencies should bear no interest. Provision should be made for "quickie” refunds. In the alternative interest should be payable on deficiencies and refunds after a certain date. (This correspondingly applies to the various provisions of subtitle F, pt. V.)

204. Section 6073: The final estimate of individual income tax should be made by February 15 to enhance the prospect of final returns in the light of the fact that W-2's become available generally at January 31. (This correspondingly applies to secs. 6015 (f) and 6153 (a).)

205. Section 6073 (c): The restriction as to one amendment of a declaration between installment dates should be eliminated. (This correspondingly applies to the inference in sec. 6074 (b).)

206. Section 6075 (b): The due date for the gift-tax return should be April 15 to coordinate with the due date of individual income-tax returns.

207. Section 6081 (b): To be realistic, termination of extension of time for filing returns should require a return by not less than 20 days from the termination notice.

208. Section 6653 (a): The negligence penalty for intentional disregard of regulations should not be imposed if the taxpayer disagrees in good faith and attaches a statement of his position to the return.

209. Section 6654: The effective date as to additions for failure to pay estimated tax should not be before January 1, 1955, at least for tax years beginning after enactment, so as to avoid penalizing declarations already filed in good faith under existing law.

210. Section 6654: The amounts for failure to pay adequate estimated tax called "additions" should be called “interest” and thereby become deductible. (This correspondingly applies to sec. 6655.)

211. Section 6901 (d): The intent set forth on page A422 of the Ways and Means Committee report about extension of time to file a claim for refund by a transferee during the extended period arising out of overpayments by the transferor should be made clear in the statute.

212. Section 7502 (a): The date of mailing of a return should be treated as the date of filing. The exclusion of returns should be eliminated. It should also be made clear that this applies to Tax Court petitions.

213. Section 7851 (a) (1) (A): The provision that excludes from the operation of the 1954 code taxable years beginning after December 31, 1953, and ending prior to date of enactment, should be reexamined. It creates the possibility of getting out from under the loophole closeup during that period.

The CHAIRMAN. Mr. Reynolds, identify yourself to the reporter and make yourself comfortable.

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Mr. Chairman, my name is Lester E. Reynolds. I am a resident of West Hartford, Conn. I am presently employed as vice president and treasurer of the Connecticut Light & Power Co., in Berlin, Conn.

I am here to oppose, on behalf of our company, section 110 of H. R. 8300. That section relates to the tax consequences of a lease agreement in which the lessee has agreed to reimburse to the lessor the income tax assessed on the annual rental payments specified in the lease agreement.

In addition to this oral testimony, I have prepared a detailed written statement which I wish to have placed in the record.

The CHAIRMAN. It will be included in the record. (Mr. Reynolds' prepared statement follows:)



The Connecticut Light & Power Co., of Berlin, Conn., is a public utility engaged in the manufacture, sale, and distribution of electricity and gas throughout a substantial part of the State of Connecticut and is esubmitting this written statement in addition to oral testimony by its vice president and treasurer in opposition to section 110 of H. R. 8300. That section relates to the tax consequences of a lease agreement in which the lessee has agreed to pay the lessor's income tax on the annual rental payments specified in the lease agreement.

Section 110 proposes a radical change in the practice which has been followed by the Treasury Department for at least 30 years with respect to income-tax payments made by lessees on behalf of lessors. The company's opposition is primarily based upon the fact that section 110 imposes a tremendous new burden upon lessees who are operating under leasing contracts entered into many years ago. These lease contracts, some of which were entered into prior to enactment of the 16th amendment, run for 99 years or even 999 years, and their terms cannot be changed in order to avoid the disastrous effects which section 110 will have.

The Connecticut Light & Power Co. is currently operating part of their property as lessee under a 999-year lease entered into in 1906, which provides that the lessor corporation is entitled to a fixed annual rental after payment of all taxes and expenses imposed upon the lessor with respect to such rental.

Under this lease agreement, this company, as lessee, is obligated to pay the Federal income taxes imposed upon the lessor with respect to the annual rental. The Federal income tax so imposed on this rental payment and paid by the lessee has, over a long period of years, been considered by the Commissioner of Internal Revenue as additional taxable income to the lessor (letter of instruction issued in 1923 by Commissioner to all branches of the Bureau). That result, in turn, requires the lessee to pay an additional or second income tax for the lessor, but this second reimbursement of tax has, prior to 1952, never been considered as taxable income to the lessor.

Within the past 2 years a change in the policy of the Treasury Department with respect to the tax treatment of the income tax payments made under such longterm lease agreements has created very serious problems for lessees.

By proposing section 110 of H. R. 8300, the Ways and Means Committee of the House has apparently intended to correct the current confusion and to fix the tax consequences of such lease arrangements to both the lessor and the lessee. However, section 110, inadvertently perhaps, removes almost none of the inequities and absurdities of the present Treasury Department rule and in addition denies to lessees the right to deduct very substantial amounts which constitute ordinary and necessary business expenses.

In these circumstances, it is respectfully submitted that the Congress reject the formula of section 110 and should write into H. R. 8300 the practice and policy followed by the Treasury Department for at least 30 years prior to 1952.

Prior to 1952, it had been the consistent practice and policy of the Treasury Department for at least 30 years to include in the taxable income of the lessor the rental income plus the tax paid by the lessee on account of the rental, but not to include the next, or second, step (being the tax on tax) into the lessor's income. This latter reimbursement by the lessee to lessor was considered as a simple reimbursement of expense and not taxable income. As a part of that long-standing practice and policy, the Treasury Department recognized the right of the lessee to deduct as an ordinary and necessary business expense

(1) The annual rental,
(2) The income tax paid by the lessee on account of the annual rental, and

(3) The second income tax paid by the lessee on account of the first income tax payment.

This may be illustrated as follows: Rental paid by lessee--

$100,000 Income tax on lessor at 52 percent.

52, 000 Income tax on such tax--

27, 040

Total cost of lease to lessee all deductible as an ordinary and
necessary business expense-----

179, 040 The lessor, using this example, was required to report, for income-tax purposes, only $152,000, on which a tax of $79,040 would be paid. The lessee was entitled to deduct, as a business expense, the total of $179,040, consisting of the rental plus all taxes of the lessor, so that the lessee's net cost of rental and tax would be $179,040 minus $93,100, or the amount of $85,940.

In 1952, the Treasury Department adopted a new policy which, in general, requires the pyramiding of the taxes on income taxes into the lessor's income, and allows the lessee, as a business-expense deduction, all such taxes. Under this method, the income taxes to be paid by the lessee on behalf of the lessor, including each successive tax on tax in the example cited, reach the absurd amount of 108 percent of the stipulated annual rental as shown in the following schedule: Rental paid by lessee--

$100,000 Tax on tax on tax, etc., at 52 percent..

108, 333

Total cost of lease to lessee_

208, 333 Under this method the entire $208,333 is includible in the lessor's taxable income and the same amount is deductible by the lessee as a business expense. The net cost of the lease to the lessee after this deduction is $100,000 as against $85,940 under the method followed by the Service for 30 years prior to 1952, as shown below: Total cost of lease deductible by lessee_

$208, 333 Tax at 52 percent--

108, 333

Net cost of lease_

100,000 More significant, assume the lessee has a net operating loss and thereby loses the benefit of the deduction of the $208,333. It is easy to see that in these circumstances lessees may be pyramided into bankruptcy.

The unequal and absurd results under the pyramiding system are also apparent when the lessor and the lessee fall into different corporate tax brackets, as will be illustrated hereinafter.

Pyramiding is also cumbersome, difficult, and costly to administer. This administrative burden falls on the Treasury Department and the lessor and lessee-taxpayer as well. In computing the lessor's pyramided income taxes, it is necessary either to go through a series of laborious mathematical computations, or to use an algebraic formula, which, as already noted, most unrealistically attributes income to the lessor in an amount more than double the specified rental.

The pyramiding system produces such patently absurd and detrimental results that apparently even the Treasury Department is willing to abandon it. Section 110 has apparently be designed to eliminate it, but the section is a kind of Trojan horse for it writes into law virtually all the adverse effects of pyramiding under the guise of eliminating them.

Section 110 proposes an entirely new rule with respect to the income-tax treatment of the tax payments made by lessees on behalf of lessors. The section pro

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