Lapas attēli
PDF
ePub

poses, with respect to leases executed prior to January 1, 1954, to exclude from the gross income of lessors the amount of income-tax payments made by lessees on behalf of lessors. It also proposes to deny to lessees any tax deduction on account of such income-tax payments.

It is immediately apparent that section 110, as now written, violates consistent and long-established tax accounting principles by denying lessees a deduction for an ordinary and necessary business expense. The provision approved by the House committee is that the lessor be required to report as income the annual rental but not the tax on the rental, and that although the lessee pays or reimburses to the lessor the amount of such tax, the lessee is not to be allowed to deduct the tax as an item of business expense. The result is, using the figures of the previous examples, that the lessee will be entitled to deduct less than two-thirds of the actual cost of the lease : Rental paid by lessee.

$100,000 Tax paid by lessee for lessor--

52, 000

Total cost of lease contract to lessee

152, 000

Allowable deduction to lessee--

100, 000 Thus, the lessee will pay out $152,000 as the total cost of the lease, and by deducting $100,000, will reduce his taxes by $52,000, making the net cost of the lease $100,000, exactly the same as under the pyramiding system.

There are other inequities of the pyramiding system which are perpetuated by section 110. One of the worst of these is the harsh result where the lessor corporation is in the 52 percent income tax bracket and the lessee corporation is in the 30 percent tax bracket. .

In order to make clear the adverse effect of both the pyramiding system and section 110, let us assume a lease agreement entered into while the Treasury Department's pre-1952 practice was in effect. The rental is fixed at $100,000 after payment of lessor's taxes. Further assume that the lessee's income is $200,000 before deducting the costs of the lease. The lessee's net income after taxes will be as follows: Lessee's income before deducting cost of lease-

$200,000

[blocks in formation]

14, 672 Compare the foregoing result, which, under the pre-1952 Treasury practice, was anticipated at the time the lease agreement was entered into, with the results both under section 110 and pyramiding:

Net income of lessee after taxes.

Sec. 110

Pyramiding

$200,000

$200,000

Lessee's income before deducting cost of lease
Lease rental.
Income taxes paid for lessor.

$100,000

52,000

$100, 000
108, 333

152, 000

Total cost of lease to lessee. Amount deductible by lessee

208, 333

100,000

208, 333

Taxable income of lessee
Income tax of lessee.

100, 000
46, 500

18, 333
None

Total.
Less: Income tax paid for lessor, not deductible.

53, 500
52, 000

Net income of lessee after taxes..

1,500

18, 333

1 Loss.

It will be readily seen that the pyramiding method converts a lessee-taxpayer with net income after taxes into one with a net loss. Section 110 unrealistically increases the tax bracket of the lessee-taxpayer from 30 percent to 52 percent and at the same time reduces what is at best a small net income to a nominal figure.

Section 110 also denies to the lessee the deduction of a legitimate ordinary and necessary business expense. The Ways and Means Committee announced that the purpose of the new bill is “to bring the income-tax provisions of the code into harmony with accepted accounting principles.” The proposed treatment of the lessor-lessee relations above referred to completely violates this purpose, as there is no recognized accounting principle which deprives a taxpayer of a deduction for an ordinary and necessary business expense incurred in the operation of income-producing property.

Moreover, the theory of section 110 appears to be incorrect in that it is made applicable only to leases entered into prior to January 1, 1954. Most long-term leases were executed even prior to imposition of any Federal income taxes. Leases executed after passage of the income-tax amendment have been made in the light of the tax treatment accorded to such leases by the Treasury prior to 1952. Generally speaking, the long-term leases falling into these two classes are not subject to change, so taxpayers are prevented from correcting by amendment the inequities which section 110 will produce. It is, therefore, suggested that if any such rule is to be written into the law, the section should be made applicable only to leases executed after the enactment of the statute. This will place all taxpayers on notice that a change has been made in the tax treatment of leases providing for the payment of income taxes and will permit them to contract accordingly.

However, the fact that the Treasury Department is attempting to impose the absurd rule of pyramiding taxes into income with respect to existing leases, after having followed a different and more reasonable practice for at least 30 years, indicates the need for enactment of a uniform rule both for preexisting and future lease agreements.

Our proposal is that Congress write into H. R. 8300 the long-standing pre-1952 rule of the Treasury Department. It is the most logical and equitable policy from the standpoint of taxpayers and, from the standpoint of revenue administration, is workable and easy to administer. It is also submitted that that policy presently has the sanction of the courts. The question was presented to the United States Supreme Court in 1929 in two cases: Old Colony Trust Company v. Commissioner (279 U. S. 716); and United States v. Boston & Maine R. R. Company (279 U. S. 732). The Boston & Maine case relates to the same kind of lease agreement as that held by the Connecticut Light and Power Co. under which the lessee has agreed to assume the income taxes of the lessor. The Old Colony case, involving the same principle, was concerned with an agreement by an employer to pay an employee a sufficient sum to give him annually X dollars after income taxes. The taxpayers contended in both those cases that the payment by the lessee and employer of the lessor's, or employee's, income taxes did not constitute additional taxable income to the lessor or employee. The taxpayers argued that if the tax payments constituted additional income, each such payment would create further taxable income ad infinitum, resulting in an absurdity which Congress could not have contemplated.

In its brief the Government assured the Supreme Court that since 1923 the Bureau practice was to add only the original tax to taxable income, and that it had never treated the additional or second tax as income. As evidence that this was the established practice of the Treasury Department, there was attached to the Government's brief in the cases cited above a letter of instructions issued in 1923 to all branches of the Bureau by Internal Revenue Commissioner Blair, setting forth the method to be followed in computing the taxable income of the lessor, as follows:

“The lessor corporation at the close of its taxable year should without taking into account the amount of income and profits taxes paid in its behalf by the lessee corporation determine what its gross income and net income are, then compute the amounts of income and profits taxes properly assessable against a similar amount of income, accrue upon its books additional gross income in an amount equal to the taxes so computed, and include such amount in its return as additional gross income. The amount of income and profits taxes assessable against the lessor corporation is to be computed on the amount of net income as shown in that return.'

[ocr errors]

This was an unequivocal representation by the Government to the Supreme Court that it was its consistent practice in instances where a lessee was obligated to pay the taxes of a lessor to consider as additional income to the lessor only the initial tax computed upon the net income of the lessor without taking into account the amount of the additional taxes paid by the lessee for the lessor.

The Government also stated to the Supreme Court in the cases cited above:

“We think that in a case where the parties have placed themselves in such a position that extreme hardship will follow the literal application of a principle, the Treasury Department is not fairly to be censored if it fails to apply its theory literally in order to avoid absurd consequences."

The Supreme Court endorsed the practice and policy of the Treasury Department by stating in the Boston & Maine case that "* * * it should be added that neither before nor since 1923 has any algebraic formula been used by the Bureau in computing taxes" (279 U. S. 732 at 736).

It was not until 1952 that the Treasury Department made any change in that practice and policy. In all intervening years, the Congress took no action to require pyramiding. In these circumstances, that practice and policy must be deemed to have the force and effect of law.

Yet, on March 12, 1952, the Commissioner issued mimeograph No. 6779 reyersing the long-established prior practice, and holding that where a lessor receives an annual net return after income taxes and other expenses, “the lessor is deemed to have received as rental not only the stipulated rental but in addition thereto all Federal income taxes paid by the lessee to or for the account of the lessor."

Subsequently, on October 14, 1952, the Commissioner issued IR mimeograph 53 providing that mimeograph 6779 would be applied only with respect to taxable years beginning on and after January 1, 1952.

Application of this mimeograph requires the imposition of a tax upon a tax to the point of infinity, and would produce the absurd result which the taxpayers questioned in the Old Colony and Boston & Maine cases, and which the Treasury Department stated to the Supreme Court was contrary to its policy.

By reason of present high income tax rates, the principle of pyramiding is not only economically unsound because it distorts income but approaches confiscation.

The proposed rule of section 110 of H. R. 8300 is even less satisfactory than the pyramiding system. It not only produces some of the same distortions but also denies the lessee the deduction of a legitimate business expense.

The fact that it is made applicable to lease agreements entered into prior to January 1, 1954, and not to prospective lease agreements is unreasonable and illogical. The effect of section 110, as presently drafted, is wholly contrary to the long-standing practice of the Treasury Department not to apply change of policy retroactively. This is particularly true where the taxpayer in his business transactions has complied with the previously existing policy and practice of the Treasury Department. It is difficult to understand why a new rule should be adopted for leases entered into many years ago at a time either when there were no Federal income taxes or the pre-1952 Treasury practice was so well established as to have the force and effect of law. Presumably, under section 110 as now proposed, lease agreements entered into on or after January 1, 1954, will be subject to the absurd pyramiding rule, although if it should be established in litigation that the pyramiding policy of the Treasury Department is illegal, they would then be subject to the Treasury's pre-1952 rule, which is fair and reasonable.

It is submitted that the Congress should adopt one rule with respect to all lease agreements past or future, and that that rule should embrace the longstanding pre-1952 Treasury practice and policy.

Mr. REYNOLDS. 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. Our opposition is primarily based upon the fact that section 110 imposes a tremendous new burden upon lessees who are operating under lease agreements entered into many years ago. These lease contracts, some of which were entered into prior to the 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.

[ocr errors]

а

My company is currently operating 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 imposed upon the lessor with respect to such rental.

Under this lease agreement, my 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 upon 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. That result, in turn, requires the lessee to pay an additional or second income tax for the lessor, that being a tax on the tax, but this second reimbursement of tax has, prior to 1952, never been considered as taxable income to the lessor. Prior to 1952, it has been the consistent practice and policy of the Treasury Department for at least 30 years, and sanctioned by the courts, 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, in the lessor's income.

This latter reimbursement by the lessee to the lessor was considered as a simple reimbursement of expense and not taxable income. It might be illustrated by the fact that I walk uptown and buy a dozen pencils for $1 to be used in my work. When I come back on the job, the company reimburses me for the $1 spent. Certainly, that isn't income to me; but, obviously, it is an expense. to my company.

As part of that longstanding practice, the Treasury Department allowed the lessee to deduct as an ordinary and necessary business expense (1) the annual rental; (2) the first income tax paid by the lessee on account of the annual rental; and (3) the second income tax reimbursement by the lessee on account of the first income-tax payment.

That was a wholly fair and satisfactory tax policy, inasmuch as the lessee was allowed a tax deduction for all of the taxes which were required to be paid for the benefit of the lessor.

In 1952, after 30 years of following the above-described practice, the Treasury Department adopted a new policy. That new policy requires the pyramiding of taxes on income taxes into the lessor's income to the point of infinity. Under this method, the income taxes paid by the lessee must include each successive income tax on income tax. As pointed out in my detailed written statement, at the current corporate tax rate of 52 percent, the income taxes to be paid by lessee on behalf of the lessor reach the absurd amount of 108 percent of the stipulated annual rental.

Although the Treasury Department under its new policy allows the lessee to deduct all the taxes paid with respect to the lessor's rental income, it nevertheless results in a tremendously greater burden upon the lessee than the former policy. Furthermore, if the lessee operates over a period of several years with annual net operating losses, the benefit of the deduction is entirely lost and the lessee may be quickly pyramided into bankruptcy.

In addition, when the lessor and the lessee fall into different corporate tax brackets, this pyramiding system produces unequal and harsh results in the case of a small corporate lessee, whose tax rate is 30 percent.

[ocr errors]

The pyramiding system produces such patently absurd and detrimental results that apparently even the Treasury Department is willing to abandon it. Presumably section 110 has been designed for that purpose but, inadvertently or designedly, it writes into law virtually all the adverse effects of pyramiding, under the guise of eliminating them.

Section 110 proposes an entirely new rule for leases executed prior to January 1, 1954. The section provides for the exclusion from the gross income of lessors, the amount of all the income tax payments made by lessees. At the same time, it proposes to deny to lessees any tax deduction on account of such income tax payments. It is immediately apparent that section 110 violates consistent and long-established tax accounting principles because it denies lessées a deduction for an ordinary and necessary business expense.

The result is, as pointed out by example in my written statement, lessees will be entitled to deduct for tax purposes less than two-thirds of the actual cost of the stipulated rental.“ Section 110 also perpetuates the extremely harsh result of the pyramiding system where the lessee corporation is in the 30 percent tax bracket and the lessor corporation is in the 52 percent tax bracket. Under the longstanding pre-1952 Treasury practice, a lessee may have earned a net taxable income of approximately $20,000. When the pyramiding system is applied, that same taxpayer will have an annual operating loss of several thousand dollars. Under section 110, the $15,000 net income after taxes is reduced to $1,500. Whereas, in most cases, the lease agreements cannot be broken, the lessee has no choice but bankruptcy.

Finally the theory of section 110 appears to be unsound in that it is made applicable only to leases entered into prior to January 1, 1954. Most long-term leases to which the section will apply were executed even prior to the enactment of the Federal income tax laws. Leases executed after the passage of the income tax amendment will have been made in the light of the longstanding pre-1952 Treasury practice.

Generally speaking, all of these long-term leases are not subject to change. Taxpayers are, therefore, prevented from correcting the inequities which section 110 will produce. This is retroactivity of the worst sort. If the rule set forth in section 110 is to be adopted at all, it should be made applicable only to leases executed after its enactment.

As section 110 now stands, it prescribes no law whatever for leases executed in the future. Will the Treasury Department apply the rule of pyramiding or its pre-1952 practice, or will it try to make use of the rule of section 110 for future leases? Nobody knows.

This situation indicates the need for a uniform rule both for preexisting and prospective lease agreements.

My proposal is that Congress write into H. R. 8300 the longstanding pre-1952 rule of the Treasury Department. From the standpoint of taxpayers it is the most fair and equitable policy and from the standpoint of revenue administration it is workable and simple to administer. Lessors and lessees with lease agreements which were entered into before 1913 have been able to operate satisfactorily under that longstanding rule. Leases executed between 1923 and 1952 have been based upon that rule. It avoids the extreme and unfair results of both the pyramiding system, and section 110. It provides a rea

[ocr errors]
« iepriekšējāTurpināt »