"LAW APPLICABLE TO COMPUTATIONS. In determining the amount of any net operating loss carryback or carryover to any taxable year, the necessary computations involving any other taxable year shall be made under the law applicable to such other taxable year, except that a net operating loss sustained in any taxable year beginning after December 31, 1953 shall not be adjusted by the modifications set forth in subsection (d) hereof in the earliest of the 7 taxable years to which (by reason of par. (1) of subsec. (b) hereof) such loss may be carried. The preceding sentence shall apply with respect to all taxable years, whether they begin before, on, or after January 1, 1954."

In support of this amendment, we wish to point out that it will not affect the computation of excess profits taxes. Subsection (f) (3) of section 172 provides that excess profits net income shall be computed as if this section had not been enacted.

The coal industry has a particular stake in the amendment herein recommended. That stake arises because of the depressed condition of the industry and the depressing outlook for the industry. The loss of coal markets to imported residual oil, to domestic petroleum, and to natural gas are too well known and too well documented before various committees of Congress to require further substantiation here. It is enough to point out that in 1954 a substantial number of coal companies will suffer net operating losses. At least for the reasonably foreseeable future, no change in the economic outlook of the industry is in sightthe shrinkage of markets promises to continue for a number of years.

If the amendment advocated herein is adopted, it will have the effect of partially removing the recognized inequity involved with respect to losses sustained in 1954 and 1955, and thereby enabling some coal companies to remain above water for a little longer. If this amendment is not adopted, many coal companies will never receive any benefit from the change now contained in section 172 because as it stands this change has no application to losses sustained before 1956. Companies with a period of successive loss years beginning in 1954 (and it appears that there will be a number of coal companies in that category) may well be forced out of business before any benefit is received from section 172 unless it is made applicable to losses sustained in 1954.

DEFINITION OF THE PROPERTY

Section 614 of H. R. 8300 contains a definition of the property for the purpose of computing the depletion allowance. At present there is no such definition in the law, but regulations 118 provide such a definition in section 39.23 (m)-1 (i). In the regulations it is specified that "where two or more mineral properties are included in a single tract or parcel of land, the taxpayer's interest in such mineral properties may be considered to be a single 'property,' provided such treatment is consistetly followed."

The lack of a statutory definition of the property has in the past occasioned considerable litigation, and therefore a sound definition appears to be desirable. Hower, section 614 in its present form appears to be seriously deficient in some respects.

The aggregation of interests permitted by existing regulations and decisions is in many cases applied for the purpose of cost, or unit, depletion as well as for the purpose of percentage depletion. In many cases a mining operation is composed of a large number of small tracts of land acquired at different times and from different sources. There are in existence a number of such mining operations which are composed of a number of tracts and which became operative so long ago that records are no longer available as to the cost basis of each and every individual interest therein. The number of such cases has been increased by the fact that under present law the operator has been permitted to aggregate such interests (provided such treatment was consistently followed) for both cost depletion and percentage depletion purposes.

After defining "property" as meaning each separate interest owned by the taxpayer in each mineral deposit in each separate tract, section 614 permits the taxpayer to aggregate such interests under specified conditions, "but only for the purpose of computing the percentage depletion allowance."

Even though the taxpayer may be computing his depletion allowance on the percentage basis, he must of course be able to determine his cost or unit depletion. If section 614 is enacted in its present form there will be a large number of taxpayers for whom it will be impossible to comply with the requirements of the section.

If the same aggregation is permitted for cost depletion purposes as is permitted for percentage depletion purposes this treatment will not impose insoluble problems were a portion of the aggregated property is disposed of. When such an event occurs, the taxpayer determines gain or loss by deduction of adjusted basis from the selling price. If the taxpayer's records do not permit him to establish an adjusted basis of the particular portion disposed of, then he simply fails to establish any reduction of the selling price in the determination of gain. The Government, therefore, will lose nothing by permitting the same aggregation for cost depletion purposes as is permitted for percentage depletion purposes.

In addition to the essential change in section 614 discussed herein, there are a number of desirable changes which we feel should be made in the statutory definition of the property. The taxpayer should be permitted to form more than one aggregation in a given operating unit where circumstances make it desirable to do so. The taxpayer should be permitted a new election as to aggregation of interests when there is a substantial change in holdings. Lessors should be permitted a reasonable aggregation of mineral interests. These matters are discussed in detail in exhibit A attached to the statement presented to this committee yesterday by Mr. Henry B. Fernald on behalf of the American Mining Congress. We have examined exhibit A to Mr. Fernald's statement and concur in the recommendations therein. We will not burden the record by repetition here of the reasons therein set forth.

DEFINITION OF NET INCOME FROM THE PROPERTY

When the percentage depletion provisions applying to coal and metal mining were first made a part of the revenue statutes in the Revenue Act of 1932 and reaffirmed in the Revenue Act of 1934, the definitions of "gross income from the property" and "net income from the property" upon which the allowable computations of percentage depletion were based, were left by Congress for inclusion in the regulations by the Commissioner of Internal Revenue.

The mine operators protested the definitions drafted by the Commissioner for inclusion in the regulations on the grounds that they did not express the clear intent of Congress. As a result, a group of mine operators and their representatives met with the officials of the Treasury Department late in December 1932 to discuss the matter. In this conference, it was agreed the definitions drafted by the Commissioner did not express the intent of Congress. However, as the regulations containing the definitions drafted by the Commissioner had, in the interim, been printed in bound form and been delivered to the Treasury Department and were ready for issuance, the Treasury representatives expressed reluctance to withdraw said regulations on the ground such a change could not be made and have the regulations issued in time for use in connection with the returns due to be filed March 15, 1933. To meet this situation, it was proposed that the regulations be issued as printed with the understanding the definitions would be interpreted and applied according to the meaning of the act as agreed to in that conference. The operators agreed to this procedure. The regulations were thus issued and the definitions were applied as agreed to up to about the latter part of 1938.

Beginning in about 1938 and progressively over subsequent years, the Commissioner of Internal Revenue made various changes in the interpretation and application of these definitions contained in the regulations, all detrimental to the mining operator entitled to an allowance as depletion. Some of these changes were covered by rulings issued by the Commissioner. However, in the main, the Commissioner merely took the position that his prior allowances had been contrary to the expressed wording of the regulations and the changes being made were for the purpose of complying with those regulations.

Since 1938 the Commissioner has progressively and gradually set up additional deductions not previously deemed deductions from gross income in determining net income from the property. Many of these deductions have no relation to the production from the particular property upon which the depletion is claimed. Since the law does not contain a definition of "net income from the property," but leaves the matter to the discretion of the Commissioner, the courts have generally upheld the Commissioner's determinations. For example, in Sheridan Wyoming Coal Co. (125 Fed. (2) 42), interest payments on outstanding bonds, bond discount, and expense of amortization of bonds, whether or not said bonds applied to the particular property upon which depletion was claimed, were held to be proper deductions from gross income in computing net income from the

property. There have been other equally vital decisions detrimental to the coal operator.

In the Revenue Act of 1942 the Congress, at the request of the mining industry, adopted a definition of "gross income from the property." However, no definition of "net income from the property" has been put into the law. In section 613 (a) of H. R. 8300 the phrase "net income from the property" has been replaced by the phrase "taxable income from the property." The report of the Committee on Ways and Means on H. R. 8300 states, at page A184, as follows:

"As used in section 613, the term 'taxable income from the property' means the same as 'net income from the property' in existing section 114 (b) (3), (4) (A), and no substantive change is intended by the change in language. In computing taxable income from the property it is intended that there be taken into account all deductible items (other than depletion) including such items as administrative and financial overhead expenditures and taxes which, under sound accounting principles, are attributable to extraction or processes treated as mining."

Thus, if H. R. 8300 is adopted in its present form it will confirm by law the reduction of the percentage depletion allowance which has come about over the years by the regulations promulgated by the Commissioner. We do not believe that those regulations express the intent of Congress when it enacted the percentage depletion provisions, and we hope they do not reflect the intent of Congress at this time. We therefore ask that in section 613 (a) the phrase. "taxable income from the property" be replaced by the existing phrase, “net income from the property," and that a new subsection designated subsection (d) be added to section 613, reading as follows:

"(d) DEFINITION OF NET INCOME FROM THE PROPERTY. As used in this paragraph the term 'net income from the property' means the gross income from the minerals from the property, less the allowable deductions directly attributable to the mineral property upon which the depletion is claimed and the allowable deductions directly attributable to the processes described in paragraph (c) of this section insofar as they relate to the products of such property, including operating expenses, development costs properly charged to expense, depreciation, property taxes, losses sustained, etc., but excluding any allowance for depletion. Such expenses or deductions shall not include expenses or deductions attributable to, or arising out of expenditures on, other property or assets, irrespective of whether such property or assets are income producing or active. Deductions not attributable to, or arising out of, particular properties, processes or assets, such as general overhead, shall be fairly allocated to all properties, processes, and assets whether active or inactive. The term 'general overhead' as used herein shall be deemed to mean the overhead relating to the property but shall exclude deductions and expenses of financial overhead of the taxpayer such as interest, taxes based on or measured by income, capital stock taxes, and the like."

The proposed amendment merely provides, as we believe was originally intended by Congress, that expenditures which have no connection with the "net income from the property" should not be deducted from "gross income from the property" in arriving at such net income.

The principal items involved in our proposed definition are interest on indebtedness and taxes measured by income. Under present Bureau rulings, when the 50-percent depletion limitation on net income from the property applies (practically universally in the coal industry because of the industry's low margin of profit, if any), a coal company which is in debt receives substantially less depletion than a coal company under exactly similar conditions which is not in debt. On its face, this is not equitable between taxpayers.

Under present Bureau rulings, a coal company which is located in a State which imposes an income tax receives less depletion on its Federal return than another company which is identical in all respects except that it is located in a State where there is no State income tax. There seems to be no logical reason why this inequity should exist-no reason why the amount of the Federal depletion allowances should be dependent upon whether or not the State imposes an income tax.

Further, within the same State the amount of Federal depletion allowance may be dependent upon the form of ownership. Some States impose income taxes upon corporations but not upon individuals or partnerships. In such States two coal companies which are located in the same area and which are identical in

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all respects except for the form of ownership will receive different Federal depletion allowances.

A majority of the States which provide percentage depletion for the natural resource industries pattern their provisions after the Federal laws and therefore require the deduction of Federal income taxes in determining the net income upon which depletion is based. In those States the determination of the Federal depletion allowance (which depends upon the amount of the State income tax), the State depletion allowance (which depends upon the amount of the Federal income tax), the Federal income tax (which depends upon the amount of the Federal depletion allowance), and the State income tax (which depends upon the amount of the State depletion allowance) involves the finding of four unknowns-an exercise. in higher mathematics which is many times beyond the ability of many tax practitioners, much less the ability of the small taxpayer. These inequities and complications would be eliminated if section 613 were amended in the manner set forth above-to provide, in substance, that expenditures which have no connection with the "gross income from the property" shall not be deducted from "gross income from the property" in arriving at the net income upon which depletion is based.

The CHAIRMAN. Mr. Roger Milliken. Sit down, Mr. Milliken and make yourself comfortable.

STATEMENT OF ROGER MILLIKEN, DIRECTOR, AMERICAN COTTON MANUFACTURERS INSTITUTE

Mr. MILLIKEN. Thank you.

Mr. Chairman, Senator Martin, my name is Roger Milliken. I am president of Deering, Milliken & Co., Inc., a textile concern, and director of the American Cotton Manufacturers Institute. I am appearing before you as spokesman for the latter organization, and I am going to discuss the subject of depreciation.

The American Machinists magazine says that the United States of America has the world's most backward depreciation policy. This was recognized by Congress in World War II, and in the Korean war. when necessity certificates were issued to stimulate the building of new productive capacity, and it is reaffirmed by the proposal in H. R. 8300 to substitute what is supposed to be a modern approach for this outmoded system.

The willingness of Congress to come to grips with this problem is most encouraging. Unfortunately, the provisions now contained in H. R. 8300 will not accomplish this objective. And this is most simply shown by means of a chart.

Under present law the system most commonly used is the straightline depreciation. The specific rate varies with the assumed life of the capital asset, but for the machinery and equipment as a whole, the average is 6 percent a year, according to the Department of Commerce figures. Under this arrangement, therefore, the total cost of such an asset is charged off in 161% years. And this is shown by our zero line here on the chart, with the years down below and the percentages on this side.

We show that under the normal methods used, the average asset in industry is charged off completely in 16% years.

Now, even at present the taxpayer is allowed to use a declining-balance method, equal to 111⁄2 times the straightline rate. This is shown by the shaded area-the advantages are shown by the shaded blue area, and the disadvantages are shown by the shaded red area. And you will see there is a slight advantage to the taxpayer in the earlier

years of using this declining-balance method, and a disadvantage in the later years.

Now, all that H. R. 8300 does is to liberalize this alternate provision, which very few companies use, because it is of no value, to 2 times the straight-line value, or 200 percent. And the dark blue shows the cumulative advantage of the 200-percent declining balance method, and the dark red shows the disadvantage of it.

You will see that at the peak of its advantage, a company electing to use it would only be approximately 11 percent better off than if he chose to use the 160-percent declining method, which he now has a right to use. And at the end of 16% years, when the average asset in American industry would be completely charged off, the taxpayer electing the 200-percent declining-balance method would be 12 percent worse off than if he stayed with the old method.

The CHAIRMAN. You think the old method is better?

Mr. MILLIKIN. I think there is little to choose between them, sir— very little to choose.

Specifically, to prove this point, we introduce the evidence that Great Britain has for many years allowed 250 percent of the straightline depreciation on declining-balance basis. In fact, this is the common method used by British taxpayers, and all informed men know of the almost complete condition of obsolescence of the British industry. Instead, the Tax Committee, the directors, and the entire membership of the American Cotton Manufacturers Institute advocate a proposal which will permit taxpayers to elect to depreciate productive equipment as follows: Buildings, 10 years; machinery, 5 years; automobiles and short-lived personality, 2 years. There will be no restriction as to maximum life. This is basically the formula of the necessity certificate, except that our proposal limits depreciation on buildings to 10 percent per annum.

The CHAIRMAN. If you were allowed to do what you suggested, what would be the advantage to your type of business?

Mr. MILLIKEN. It would be the same as to all types of businesses, namely, it would return the cash that we invest in new assets to us faster, so that we would be willing to take more risks in purchasing new machinery than we have been able to do in the past.

The CHAIRMAN. Is your particular industry subject to revolutionary changes in machinery?

Mr. MILLIKEN. Yes, sir. About the same as any other industry in America. We are not particularly pleading this case for our industry, but for America as a whole. And we will only benefit to the extent that all of industry benefits, and our economy is stimulated. The CHAIRMAN. It would take us too long to go to all the industries of the United States. I was wondering about your industry. Mr. MILLIKEN. I have been in touch with a lot of presidents of corporations in our industry, and all of them have written me that they have projects on the drawing board which they would immediately go into, provided this method of depreciation were adopted, but that they do not feel that they can do so under the present proposal of II. R. 8300.

The CHAIRMAN. The reason I asked that is that it has been claimed frequently that in foreign countries we have equipped them with the newest and most modern machinery.

Mr. MILLIKEN. That is right, sir.