for the common stock and convertible preference stock which it sold, the price allocated to the convertible preference stock was $65 per share.

Why would the section 309 tax apply to the redemption by the corporation of its series A 44 percent preferred stock? Isn't such a redemption adequately saved from tax by one or more of the exemptions provided by section 309? The answer is believed to be "No."

In analyzing how the corporation would happen to be taxed under section 309 on redemptions or purchases of its series A preferred stock in the next 10 years one cannot help but be impressed by the important part played by certain wholly arbitrary assumptions which are made by section 309 but which in the case of Hershey Chocolate Corp. are contrary to fact. In the first place the series A 44percent preferred stock is arbitrarily deemed to have been issued on January 1, 1954, although, admittedly, it was actually issued in November 1949 in reclassification of a convertible preference stock issued in 1927. In the second place the fact that the series A 44-percent preferred stock was not itself issued for cash but was issued (along with 1 share of series B 41⁄2-percent preferred stock and 1 share of common stock) in exchange for old convertible preferred stock has unfortunate, and arbitrarily determined, consequences under section 309. By the terms of this section no regard is paid to the fact that, from a business standpoint, the corporation in 1949 received full value for its issuance of preferred and common stock, such value consisting of the benefit accruing in eliminating the old convertible preference stock which hung like a millstone round the corporation's neck. No attention is paid to the fact that on its own merits, and prior to any public hint of the fact that a reclassification was under consideration by the management, the old convertible preference stock was selling on the New York Stock Exchange at approximately $130 per share.

On the contrary, the 1949 value of the convertible preference stock is completely disregarded, and attention is directed solely to the amount of cash which the corporation received for the old convertible preference stock in 1927. The amount so received is, I assume, then allocated as between the series A preferred stock, the series B preferred stock and the common stock issued in exchange.

Figured on this basis the cash proceeds arbitrarily treated as if received by the corporation for its series A 44 percent preferred stock is estimated by me to amount to approximately $23.96 per share.

To this amount the corporation is permitted to add an additional 5 percent, making a total of $25.15 per share. Anything over this amount paid in redemption or purchase of the present preferred stock would be subject to an 85 percent tax.

When a corporation is confronted with a tax, particularly a confiscatory tax of 85 percent, it is only natural for those most directly concerned to review what the corporation has done that gives rise to such a tax. In considering section 309 from this standpoint we note that if section 309 becomes law the corporation would be taxed because of the wide disparity between (i) the redemption price of series A 44 percent preferred stock and (ii) that portion of the price received in 1927 for the convertible preference stock which is deemed allocable to the series A 44 percent preferred stock. The fact that the price received in 1927 was a fair price at that time, arrived at by arm's-length bargaining, apparently does not save the corporation. Nor does the corporation receive any comfort from the fact that by 1949 the market value and investment position of the old convertible preference stock had risen to such point that the public holders thereof would simply not have voted for a stock reclassification unless the new preferred stock issued thereunder had terms (including redemption prices) as favorable as the terms which were actually presented to them.

In testing the nature of the section 309 tax, let us also consider what might have happened if, instead of rising in value, the convertible preference stock had remained at or around the price received for it by the corporation. If this had happened, it might have been reclassified not into 2 shares of $50 par value new preferred stock and 1 share of common stock but into 1 share of $50 par value new preferred stock and one-half share of common stock. If this had happened, then the one share of preferred stock issued in reclassification could have been redeemed without the penalty of any section 309 tax.

This, of course, comes dangerously close to saying that Hershey Chocolate Corp. would, if section 309 were enacted, be subject to tax (and an 85 percent tax at that) because, and only because, the public investors in its convertible preference stock had realized a profit on their investment.

45994-54-pt. 3-24

This also comes close to saying that the corporation would be taxed under section 309 not because it had gotten something in the way of money, property, income, or advantage, but because (without any fault of its own) it hadn't gotten something.

In fact the section 309 tax as it would apply to Hershey Chocolate Corp. is so contrary in spirit to everything that the sponsors of H. R. 8300 stand for in the fostering of investment that I cannot help but think that some unintentional error must have attended its original conception.

I may be wrong but it would appear that the sponsors of this section were laboring under the mistaken impression that whenever a corporation pays out in redemption or purchase of preferred stock more than 105 percent of the cash proceeds which it originally received when the stock (or a predecessor preferred stock) was issued, the present redemption payment as well as the original issuance must necessarily be so tainted with tax avoidance motivation that the payment must be suppressed by a confiscatory, not to mention retroactive, excise tax. With all respect, this is not true.

May I suggest that, although preferred stocks are frequently sold with redemption premiums of 5 percent, or less than 5 percent of the issue price, there may nevertheless be numerous valid and bona fide business reasons (quite unconnected with tax avoidance motivation) why there may be a greater disparity than 5 percent between the proceeds which a corporation received upon the original issuance of its preferred stock (or a predecessor preferred stock) and the amount now required to be paid to effect the repurchase or redemption of the

same.

Without enumerating all of the circumstances under which this situation has arisen or can arise, may I invite attention to the following:

(a) The issuance of a preferred stock at a time when market conditions, or the issuer's investment stature, are such that the purchasers (whether a group of investment banking houses purchasing for resale to the investing public, or a group of insurance company buyers) can successfully insist, as a condition of their purchase, that the redemption premium be more (in some historic instances, much more) than 5 percent of the issue price.

(b) The nonpayment of cumulative dividends for many years-with the result that the cost of repurchasing or redeeming the stock (including as it does the amount of dividend arrearages) may be 12 to 2 times the amount originally received for the stock. Frequently corporations meet this situation by issuing new preferred stock equal in par or stated value to the par value and aggregate dividend arrearages of the old preferred stock. In such case, the redemption price of the new preferred stock (although it may not be more than 5 percent of the par value of the new preferred stock) will necessarily be 12 to 2 times the proceeds originally received by the corporation for the old preferred stock. (c) The original issuance of noncallable preferred stock at a time (such as the end of World War I) when money rates were very high, with the result that the preferred dividend rate may have to be as high as 6, 7, or even 8 percent for the stock to be salable. Assuming that such stock is of sound investment stature, it is only natural for it to sell at very substantial premiums upon a general lowering of money rates such as has occurred over the last 20 years. Indeed, some of the oldest, largest, and most distinguished corporations in America still have outstanding in the hands of the public noncallable high-dividendrate preferred stock. Originally issued at $100 per share they may now sell on the stock exchange for premium prices, such as, for example, $178 per share, or even (in the case of one famous 8-percent preferred) $211 per share.

(NOTE. In referring to these companies I would not suggest that, but for the enactment of section 309, they would be disposed to repurchase their outstanding noncallable preferred by open-market purchases or by calls for tenders in the next 10 years. For the most part they have shown no disposition to do this in the past. What they might consider doing, however, if section 309 is not enacted, and what wouldn't be worth doing if it is enacted, would be to submit to the vote of their various classes of stockholders a plan of recapitalization under which the old noncallable preferred would be reclassified into new redeemable preferred stock or into new redeemable preferred stock and common stock. This is what some other companies having noncallable preferred stocks have done in the past. In some cases such reclassification has been soon followed by the redemption of all of the new redeemable preferred stock. It is on this type of redemption that section 309 would impose a confiscatory penalty.) (d) The original issuance of noncallable preferred stock which is convertible

into common stock and which, with a rise in the market value of the common stock, sells at a corresponding premium. The classic illustration of this is the convertible preference stock of Hershey Chocolate Corp. already discussed.

No doubt there are other examples of legitimate instances of a greater disparity than 5 percent between a preferred stock's present redemption or repurchase price and the amount originally received by the issuing corporation. May I suggest, however, that the examples which have been cited, particularly the detailed story of Hershey Chocolate Corp. itself, are sufficient to point up the dangers inherent in the basic approach of section 309.

By "basic approach" I refer to the fact that, as stated in the committee report, section 309 was primarily intended to stamp out "preferred stock bailouts" of the type unsuccessfully attacked by the Bureau in the Chamberlin case. This objective could have been, and should be, achieved by legislation which is custom tailored, or (to switch metaphors) which is pinpointed on the real target.

Section 309, however, represents an entirely different approach. Its first sentence imposes what in effect is a flat prohibition (for an 85-percent tax can be nothing else) on all payments in redemption of all preferred stocks. This is done on the theory that the five exemptions in clause (a) will cover all situations which should be exempt from the tax.

Obviously such an approach puts upon the draftsman the grave responsibility of conjuring up all the situations which should properly be excepted from the general prohibition. This responsibility is particularly grave because of the confiscatory nature of an 85-percent tax. An 85-percent tax is dynamite when it misfires.

May I suggest that in the case of Hershey Chocolate Corp. and the other instances mentioned on pages 5 and 6 the 85-percent tax of section 309 misfires, and misfires badly.

Since no one could ever be sure of carving out all the appropriate exceptions to the section 309 tax, may I suggest that section 309 should either be scrapped in toto, or be redrafted to apply only to future preferred stock bail-outs of the true Chamberlin type.

II. IMPACT OF SECTIONS 354 (B) AND 359 (A)

Let us take two corporations-corporation A and corporation B. Let us assume that each would be benefited by acquiring the stock or the assets of corporation X, through the issuance of the acquiring corporation's stock in a statutory merger or consolidation.

Let us assume that the proposed new Internal Revenue Code is so framed that such acquisition by corporation A is completely tax-free, not only to corporation A and its stockholders but also to corporation X and its stockholders. Let us further assume that under the same Internal Revenue Code a completely similar acquisition by corporation B would result in taxable gain or loss, not only to corporation B and its stockholders but also to corporation X and its stockholders. If this were the case, there would be no doubt that corporation A had received from the new revenue code a tremendous advantage in its competition with corporation B for the acquisition of the stock or assets of corporation X.

If sections 354 (b) and 359 (a) are enacted in their present form, Hershey Chocolate Corp., will be put in the same disadvantageous status above attributed to corporation B, vis-a-vis publicly held corporations as defined in section 359 (a). The apparent theory of sections 354 (b) and 359 (a) is that a publicly held corporation is, by reason of the character of its stock ownership, inherently less likely to abuse the tax-free statutory merger and statutory consolidation provisions of section 354 (b) than a corporation which is not publicly held.

With this theory in mind, let us look at the owners of the common stock of Hershey Chocolate Corp. Let us see whether they would be more likely, or would be less likely, to seek tax avoidance in statutory mergers and consolidations than would be the case with corporations which fit the publicly held definition of section 359 (a).

We will find that 69 percent of the common stock of Hershey Chocolate Corp. is owned by Milton Hershey School. This a tax-exempt charitable organization which has been ruled by the Bureau to meet not only the standards of section 101 (6) of the present code but the even more restrictive standards of a genuine educational organization as specified in sections 54 (f) (2) and 3813 (a) (2).

With all respect, I can think of no stockholder less likely to be motivated toward tax avoidance than an organization which is tax-exempt in the first place.

As for the remaining 31 percent of the common stock (now having an aggregate market value of approximately $31 million) who are its owners?

They consist of approximately 8,800 public investors. It is upon them that 31 percent of any disadvantage to Hershey Chocolate Corp., inherent in the new Revenue Code would indirectly fall. Certainly, from their standpoint the common stock which they hold in Hershey Chocolate Corp., is held for the same investment reasons as any other stocks. I am confident they would be at a loss to understand why a corporation in which there is such a large public stock interest should be placed at a disadvantage vis-a-vis other corporations whose securities are traded on the stock exchange.

I will admit that to date it has not been the policy of Hershey Chocolate Corp. to acquire other businesses and the corporation may well adhere to such policy indefinitely. It is submitted, however, that it should not be deprived of the ability, which it now has under existing law, to diversify its business through taxfree statutory mergers or consolidations if in the future the business wisdom of such course should be indicated.

Very truly yours,

W. E. SCHILLER, Treasurer.

BRIEF WITH RESPECT TO PROPOSED AMENDMENTS TO H. R. 8300

To the Finance Committee of the United States Senate.

GENTLEMEN: Consideration of the following proposed amendments to H. R. 8300 as adopted by the House of Representatives is most respectfully requested. These proposed amendments fall into two broad categories: (1) Proposed changes in certain provisions of the bill as so adopted; and (2) proposed amendments to the code not embodied in the bill as so adopted.

Under the first category the proposed amendments submitted herewith are as follows:

I

The provision in H. R. 8300 permitting consolidation of subsidiaries where 80 percent or more of the voting stock (as defined) is held within the consolidated group is a desirable modification of the code, but in its present form it appears it would work an unwarranted hardship on certain corporations. If consolidation is elected, the system would be required to consolidate all includible subsidiaries from January 1, 1954. In cases where a corporate system consisted of a number of subsidiaries, 95 percent or more of whose voting stock was owned and which had previously been consolidated, and also of another company or group of companies where the group ownership was 80 percent or more but less than 95 percent, the taxpaying system would, under the provisions of the present law, appear to be faced with 1 of the following 3 alternatives, each of which would involve the possibility of a burden or loss:

(a) To continue to consolidate all includible subsidiaries, which would subject the taxable income of the 80- to 95-percent subsidiaries to the 2-percent penalty tax on consolidation, to say nothing of losing the benefit of the $25,000 surtax exemption as to each such 80- to 95-percent subsidiary;

(b) To elect not to consolidate: This might subject the system to even greater penalty or tax loss, due to inability to offset losses of one or more of the subsidiaries in which 95 percent or more of the stock was owned against profits of other such subsidiaries, and also through the double taxation involved with respect to 15 percent of corporate dividends received from such subsidiaries; (c) To elect to consolidate, but to eliminate the penalty or loss incident to consolidating the hitherto nonconsolidated subsidiary or subsidiaries (80 to 95 percent) by disposing of sufficient stock to reduce the voting-stock ownership below 80 percent: This would involve burdens and possible losses in another form, namely, first, by increasing the minority interest in such subsidiaries, contrary to the normal desire of the holding company; then, too, the amount of stock so to be disposed of might be considerable (it could, theoretically, equal 14 percent of the stock outstanding), and with no market or an inactive market for the stock, sale thereof might involve an unnecessary and unwarranted loss which still might represent the lesser evil, considering all 3 possible alternatives. Under the present provisions of H. R. 8300, even such a disposition would not eliminate (but merely reduce) the penalty which might arise from consolidation of such subsidiaries, since it appears the system, if it elected consolidation, would be required to consolidate such subsidiaries from January 1, 1954, to the date

the holdings were reduced below 80 percent, so that an unwarranted and inequitable penalty would apply for this period, in any event.

Accordingly, it is respectfully submitted, that H. R. 8300 be amended so that(X) Where a corporate group filed a consolidated return for 1953 (or the applicable fiscal year), then it could elect to continue such consolidation as to 1954 without including therein any subsidiaries as to which it owned 80 percent or more, but less than 95 percent of the voting stock (as defined) on some designate date (date of enactment of the new statute, for example); in such event the inclusion of such subsidiaries would be permissive, but not mandatory. The system would, however, be required to include all newly acquired subsidiaries (i. e., those acquired after the designated date) as to which 80 percent or more of the voting stock was owned. Such an amendment would permit hitherto cousolidated groups to continue to consolidate without being penalized by one of the alternatives above mentioned; or

(Y) In case the amendment submitted above in X was not adopted, then, to minimize the penalty, provision should be made that where any corporate group electing to consolidate disposes of stock in subsidiaries at any time during 1954 (or, if preferred, say within 90 days after enactment of the statute) so as to reduce the holdings therein of the includible group below 80 percent such subsidiary shall not be required to be included in the consolidation for any portion of the year 1954.

II

It appears that the present provisions of the code determine the election as to consolidation according to the form of return next filed after the new statute is adopted. The writer is informed that this provision is not considered entirely clear, but there seems to be considerable opinion that, unless amended, the filing of a 1953 consolidated return after enactment of the statute would have the effect of binding the corporate group to consolidate for the year 1954 and thereafter until a new election right should arise. Thus, companies which had received extensions of time for filing their 1953 consolidated returns might unknowingly be binding themselves as to 1954 due to their ignorance of this provision and its interpretation. It is respectfully submitted that this provision of the code be clarified so as to make it plain that the new election would be evidenced by a return for the 1954 calendar year or applicable fiscal year. Under the second broad category above mentioned, the following are most respectfully submitted:

I

The provisions relating to corporate reorganizations generally are now broad enough, seemingly, to permit treatment as nontaxable of any form of reorganization where the required percentages of securities are continued in the hands of the former owners of the controlling interests, regardless of the form such reorganization may take; i. e., merger, recapitalization, or transfer of assets to a new corporation. Thus, for instance, if a recapitalization took place with an exchange, for instance of preferred for common stock, the control would continue in the hands of the true former owners (in this case the old preferred stock), the tax base would of course continue, and the accumulated surplus or deficit in earnings for tax purposes would apply to dividends thereafter declared on the new common stock in determining the taxability of such dividends to the recipients thereof.

However, if the reorganization took place by way of a transfer of assets to a new corporation in exchange for its securities, and the common stock of the new company were distributed to the preferred stock of the old, with the same ultimate result as described above, the tax basis continuing from the old to the new corporation, there appears to be considerable doubt, under the court cases, whether a tax surplus or deficit of the old company would be carried forward to the new, as it would be in the case of a recapitalization or merger. If the holders of the old preferred stock are considered as the true owners of the enterprise at the time of the reorganization, and if the operations represented an accumulated tax deficit at that time, then it would seem unfair that, in continuing their ownership in the future, they should be taxed on future dividends which were paid from capital, merely because the reorganization had taken the form of organizing a new corporation with a transfer of assets. The converse also, is true. Here, it would seem, the statutes governing taxability of dividends, and determining of accumulated earnings and profits, etc., follow the same technical treatment which formerly plagued corporate re