would not be deductible for tax purposes by the aircraft manufacturer. The rent might be equal to or even higher than the going rate in the vicinity for factory sites; but this makes no difference under section 274. In addition, it is a common provision in leases of airport sites that any building erected will revert immediately to the municipality owning the land, upon completion of the construction or at the termination of the lease. Section 274 in its present form is also susceptible to the interpretation that amortization of the cost of construction of the manufacturing plant will not be deductible, in such a circumstance. This is considered to be a shocking consequence of a provision designed to reduce the use of tax exempt securities.

With respect to existing projects, current amounts being paid or accrued by a manufacturer who has already built a plant on an airport site will, under section 274, no longer be deductible, if the municipality which owns it should make even the slightest improvement to that property through the use of the proceeds of revenue bonds. Moreover, the jeopardy affecting the amortization of the facility of this manufacturer will at once arise.

Members of the aircraft industry have built their plants on public property and have paid substantial rent for many years. It makes absolutely no difference so far as section 274 is concerned whether the land was acquired by the city or county through the sale of tax exempt securities or whether the buildings were paid for in full by the industry, which is the case in most instances. Most leases of this type give to the manufacturer the right to land and take off its planes at the airport. If a municipality should decide to repair a runway and to finance this through the issuance of industrial revenue bonds, then the entire rent of the manufacturer for an area on which his plant is located and which he has occupied for years and years will no longer be deductible as a business expense.

The effect of all this is merely to increase the rent of aircraft manufacturers by the amount of tax which they will pay through the loss of the deduction; the purchasers of the tax exempt securities are not affected in any way by this provision, since the income from such securities will continue to be exempt from the Federal income tax.

The injury which will result from the operation of section 274, if it is enacted into law, will apply to many airports throughout the country which will be restricted in their ability to expand.

It is not an answer to say that, in the future, aircraft manufacturers should locate their plants away from publicly owned airports. This is a well-established industry. It cannot be moved overnight. The development of airport property has become essentially a governmental function. Consequently, this provision is a direct impediment upon the expansion of a truly Government function and will operate as an unreasonable hardship upon the aircraft manufacturing industry.

It is recommended, therefore, that further study be given to this problem, and that, pending such study, section 274 be eliminated from this bill.

STATEMENT OF DONALD V. FRASER, PRESIDENT, MISSOURI-KANSAS-TEXAS RAILROAD Co., CONCERNING H. R. 8300

My name is Donald V. Fraser. I reside in St. Louis, Mo., and I am president of the Missouri-Kansas-Texas Railroad Co. The Missouri-Kansas-Texas, which is more familiarly known to many of you as the Katy, would be adversely affected by sections 305, 306, 309, 312, and 275 of H. R. 8300, as passed by the House of Representatives. These sections similarly adversely affect many other railroads. They would prevent the Katy and other railroads from making effective use of section 20b of the Interstate Commerce Act. In passing that act, which relates to the modification of railroad financial structures, Congress sought to protect the interests of the public, the railroads, and investors in rail securities. Recapitalizations under this section, as well as reorganizations of insolvent railroads under section 77 of the Bankruptcy Act, and acquisitions, mergers, and consolidations under section 5 of the Interstate Commerce Act would be impossible if sections 305, 306, 309, 312, and 275 are not amended so as to make them inapplicable to securities, the issuance of which is approved by the Interstate Commerce Commission.

To illustrate the irreparable harm that would result to the Katy and other railroads similarly situated now or in the future, I wish to briefly outline the

problem facing our railroad. Our stock capitalization is made up of about $66 million of 7 percent, $100 par preferred stock, and approximately an equal amount of common. From 1930 until 1952 the Katy was unable to pay dividends on its preferred stock with the result that there is now an accumulation of approximately $150 a share or a total of over $100 million. The current dividend rate of 7 percent is unrealistic and, even though we have been able to resume payments recently, we could not make the full payment of $7 which would have been necessary to avoid further accumulations. Because of this situation, we have no prospect of being able to pay off the back dividends on our preferred. The existence of these large arrearages has a substantial and adverse effect on our railroad, on the marketability of our securities, on our credit standing and, therefore, on our ability to refund our bonds at reasonable rates or obtain needed funds for the improvement, maintenance, and operation of the railroad. Furthermore, so long as this arrearage exists, the common stock, which has voting control of the property, cannot participate in earnings. The Congress, in passing section 20b, specifically recognized the needs of the Katy and cited it as an example of a road whose capital structure should be recast to avoid future financial difficulties. Accordingly, after the expenditure of great time and effort, our railroad filed with the Interstate Commerce Commission a proposed plan of recapitalization under section 20b. Unfortunately, after our hearing, it became apparent that the plan we submitted would not be acceptable to 75 percent of our security holders as required by the act.

During the intervening months we have been in the process of drafting an amended plan for submission to the Commission. There are severe limits with which we must comply in preparing such a plan. First, the Commission will not approve a plan with a total capitalization in excess of the capitalizable assets of the railroad. There is a second ceiling on the amount of securities our company may issue which is determined by the Commission by capitalizing estimated future earnings. Then the Commission has certain general standards relating to the amounts, types, and classes of securities that may be issued and a legal standard governing the allocation of new securities as between the various classes of outstanding securities. This latter standard is sometimes referred to as the priority rule under which a senior security must be granted the economic equivalent of the rights he surrenders before a junior security may be given anything.

It is essential to preserve the greatest amount of flexibility possible in order to, first satisfy the requirements and standards of the Commission, and, second, to give security holders a package of new securities in exchange for those surrendered which at least three-fourths of them will accept. Of course, as to the three-fourths accepting the plan, it is voluntary, but, as to the 25 percent that do not accept the plan, it is involuntary.

Under the present tax statute the recapitalization plan we submitted to the Commission would be tax free. In fact, our old plan was so ruled by the Internal Revenue Service. That is to say that no income or gain would have been recognized on the exchange by our stockholders since they would have received no money or other property as part of the new package. Many recapitalizations and reorganizations of railroads have been consummated without tax consequences to the holders of stock at the time of exchange of old securities for new. It has always been held that, as in the case of recipients of stock dividends who merely receive more paper representing the same interest in the corporation, no taxable incident has occurred and no tax is payable until the new paper is sold. Under sections 305, 306, 309, 312, and 275 of the bill, as passed by the House, our situation would be completely changed. We would have no real possibility of achieving a recapitalization under section 20b as I shall show by a discussion of each of these sections.

In section 305 any recapitalization involving the elimination of dividend arrearages through the issuance of new stock or securities is taxable as a dividend to the extent that the new securities are attributable to the arrearages. The proposed statute says that such a distribution is to be deemed in lieu of money."

Secion 306 (e) provides the same result in the case of interest arrearages on bonds. The effect of these sections seems to be that, if there is an arrearage of interest or dividends on outstanding bonds or stocks and new securities are issued in exchange for such bonds or stocks, then income is received on which a tax must be paid. Such a result is in my opinion wholly inequitable and wholly unfair in that it does not take into account whether there is a probability that the dividend or interest arrearage could or would be paid in cash. In all

plans of recapitalization filed under section 20b the Commission has carefully scrutinized the past and prospective earnings of the railroad in question, and, if it concluded that there was even a reasonable prospect of the railroad paying off the arrearages in the next 15 or 20 years, it has refused to approve the plan. It has taken this action a number of times. Thus, any recapitalization plan approved by the Interstate Commerce Commission is based on the premise that the security holders could not be paid in cash for the accumulated interest or dividends. I, therefore, reiterate that it is unreasonable and unfair to treat the piece of paper received under a 20b plan as the equivalent of cash that could never be received. I am certain that no such result was intended by those who drafted these provisions and that they were unaware of the effect of these sections on railroad recapitalizations.

The concept in section 305 and 306 (e) to which I have referred also is completely at odds with the treatment given stock dividends under the new bill. There it is recognized that where a company merely capitalizes surplus no taxable event occurs. I can see no real distinction between capitalization of surplus from which future dividends might be paid (as in the case of the stock dividend) and the capitalization of surplus in discharge of a dividend arrearage. money passes out of the corporation in either case and the stockholder merely gets more or different paper representing the same interest in the surplus and the same claim on liquidation that he previously possessed.

No

It must be readily apparent to anyone that, if section 305 as it presently reads is passed, we will never be able to obtain the 75-percent assents of security holders required by section 20b. Stockholders cannot be expected to vote for a plan which at the time of exchange of securities creates taxable income, but provides no money with which to pay the tax on it.

Another provision of H. R. 8300 that would substantially adversely affect recapitalizations under section 20b is section 275. This provides that interest on income bonds shall no longer be deductible for income-tax purposes. Income bonds have been widely used in railroad financing. Their issuance has been approved by the Interstate Commerce Commission in all recent reorganizations as being in the public interest and in the interest of the railroads. A plan of recapitalization for our railroad that will comply with the many standards and requirements of the Commission and at the same time be acceptable to at least 75 percent of our stockholders will have to provide for the issuance of some income bonds. The income bond has proven useful in rail reorganizations for several very valid reasons. The issuance of securities by railroads is strictly controlled by the Interstate Commerce Commission. The amount of fixed interest debt that they may issue is severely limited. The amount of income bonds is also restricted. Income bonds issued by railroads represent true debt securities having a fixed maturity and they afford railroads an absolutely necessary flexibility in reorganizations that otherwise cannot be made sufficiently attractive to secure the necessary assents of security holders. Over a billion dollars of such securities is now outstanding. Section 275 would not only affect those already issued, but would close the door to a necessary, useful, and legitimate method of recapitalization and reorganization financing for railroads. In my opinion, it would be most unjust to deny this method of financing to railroads such as the Katy, particularly when the use of income bonds has proven so helpful and beneficial to other railroads in solving their financial problems.

Finally, I would like to invite your attention to the adverse effect upon our recapitalization problem of section 309. This section imposes upon corporations an exorbitant 85-percent penalty tax if they redeem preferred stocks or income bonds. Many of the indentures under which bonds have been issued in recent years contain mandatory sinking funds for the retirement of a certain percentage of such bonds each year. Both Congress and the Interstate Commerce Commission have repeatedly stated that railroads whenever possible should buy in their securities, particularly when they can be obtained at a discount. Under many conditions section 309 would impose a prohibitive tax on a railroad company which buys in its securities either under a mandatory sinking fund or in furtherance of the policy declared by Congress and the Commission. certain that there was no intention to place the railroads between the upper and nether millstone. The committee will recognize that a railroad purchases its securities either under indentures approved by the Commission or pursuant to congressional policy and not for the purpose of avoiding taxes.

I am

I am told that in certain unregulated industries abuses have grown up which the sections I have discussed are designed to correct. I am certain, however, that none of these abuses has been found in the railroad industry and they will

never occur in our industry. Railroad financing is closely controlled and governed by the Interstate Commerce Commission. No stock or securities may be issued, no reorganization, recapitalization, merger, consolidation or acquisition may be consummated without the approval of the Commission.

It is my earnest suggestion that, if the abuses in unregulated industries warrant the adoption of sections 305, 306, 309, and 275 in their present form, the committee should not visit the sins of others on the railroads. It should take cognizance of the generic difference in railroad recapitalizations and grant them exemption by a separate section as has been done in the case of changes to effectuate FCC policy, exchanges in obedience to SEC orders, and in nonrailroad reorganizations under chapter X of the Bankruptcy Act.1 Believing as I do that the railroads are entitled to and must have equivalent treatment in order to effectuate necessary recapitalizations and reorganizations approved by the Interstate Commerce Commission pursuant to acts of Congress, I submit for the consideration of the committee a suggested new section to H. R. 8300.

As for the nondeductibility of interest problem under section 275 and the penalty tax on redemptions under section 309, although I believe that those sections are unwise and should be eliminated, in the alternative I ask the committee to exempt railroads from the provisions of sections 275 and 309.

PROPOSED NEW SECTION TO H. R. 8300 RELATING TO INVOLUNTARY REORGANIZATIONS UNDER THE JURISDICTION OF THE INTERSTATE COMMERCE ACT

(a) EXCHANGES BY SECURITY HOLDERS AND STOCKHOLDERS.

(1) IN GENERAL. No amount shall be includible in income, and no gain or loss shall be recognized if participating or nonparticipating stock or securities of a railroad corporation (as defined in section 77m of the Bankruptcy Act (49 Stat. 922, 11 U. S. C. A. 205)) are exchanged solely for participating or nonparticipating stock or securities in such corporation or in another railroad corporation, with the approval of the Interstate Commerce Commission pursuant to a plan of reorganization, recapitalization, acquisition, merger, or consolidation under the Bankruptcy Act or the Interstate Commerce Act, or in a receivership proceeding.

(2) GAIN FROM EXCHANGES NOT SOLELY IN KIND. If an exchange would be within the provisions of paragraph (1) if it were not for the fact that the property received in exchange consists not only of property permitted by such subsection to be received without the recognition of income or gain, but also of other property or money, then the income or gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and fair market value of such other property.

(b) EXCHANGES BY CORPORATIONS.

No gain or loss shall be recognized if property of a railroad corporation is transferred in a proceeding described in subsection (a) in consideration of the acquisition solely of participating or nonparticipating stock or securities of another railroad corporation organized or made use of to effectuate a plan within the provisions of subsection (a).

(c) Loss FROM EXCHANGES NOT SOLELY IN KIND.

If an exchange would be within the provisions of subsection (a) or (b) if it were not for the fact that the property received in exchange consists not only of property permitted by such section to be received without the recognition of income, gain or loss, but also of other property or money, then no loss from the exchange shall be recognized.

(d) INAPPLICABILITY OF CERTAIN SECTIONS.

Any exchange to which the provisions of subsection (a) or (b) are applicable shall not be subject to the provisions of sections 309, 305 (c), and 306 (e).

STATEMENT OF T. C. DAVIS, CHAIRMAN OF THE BOARD OF DIRECTORS, MISSOURI PACIFIC RAILROAD CO.

My name is T. C. Davis. I reside in New York City, and I am chairman of the board of directors of the Missouri Pacific Railroad Co. While there are many provisions in H. R. 8300, I am limiting my comments to sections

1 Secs. 1071, 1081, and 371.

275, 305, 306, and 309 because of the irreparable harm which will result to the Missouri Pacific if those sections are passed in their present form.

As you all know, the Missouri Pacific has been in reorganization under section 77 of the Bankruptcy Act for 22 years. Three plans of reorganization have failed and there is now pending before the Interstate Commerce Commission a fourth plan proposed by its examiners which will require still further modification before it will be acceptable to various classes of security holders. We are seeking to accomplish a reorganization of the Missouri Pacific at the earliest possible date. However, the section 77 procedures are exceedingly cumbersome and expensive. Accordingly, the debtor company is attempting to secure permission to reorganize under the less expensive, more expeditious procedures of section 20b of the Interstate Commerce Act. By section 20b (13) Congress indicated that this new procedure should be made available to railroads in bankruptcy. Therefore, the debtor is vitally interested in the effects of sections 275, 305, 306, and 309 on reorganizations under section 20b of the Interstate Commerce Act as well as reorganizations under section 77 of the Bankruptcy Act.

It will be virtually impossible for the debtor to conclude a reorganization under either section 77 or 20b if the foregoing sections in H. R. 8300 are enacted in their present form. Our 22 years of experience testify to the difficulties of achieving an acceptable plan of reorganization under section 77 even under the present tax laws. Under H. R. 8300 these difficulties would become practically insurmountable. At the same time the alternative procedures of section 20b would be rendered nugatory since the 75 percent assents of securityholders required under the statute could not be obtained. Thus, the enactment of sections 275, 305, 306, and 309 would be contrary to the public interest as declared by Congress in enacting section 77 and section 20b of the Interstate Commerce Act and for all practical purposes would nullify those statutes. Sections 275, 305, 306, and 309 also will adversely affect many other railroads that may be similarly situated either now or in the future. They will also deter or render impossible acquisitions, consolidations, and mergers under section 5 of the Interstate Commerce Act.

Sections 305 and 306 strike at the very heart of any reorganization involving the elimination of interest or preferred dividend accumulations. Under present tax statutes such a reorganization would be tax free. However, section 305 (c) of H. R. 8300 provides that any distribution of securities whether bonds or stock made in order to eliminate a preferred dividend arrearage, even though made pursuant to a plan of recapitalization or reorganization under section 20b of the Interstate Commerce Act or section 77 of the Bankruptcy Act, is taxable to the stockholder as money. This treatment is contrary to the concept of stock dividends and employee stock options wherein it is recognized that income is not realized until the stock is disposed of by the securityholder. This treatment of railroad preferred stockholders is in direct conflict with section 371 (b) which permits a hat company, which is not affected with the public interest, to reorganize tax free under chapter X of the Bankruptcy Act. This treatment is contrary to the congressional purpose in enacting section 20b of the Interstate Commerce Act, is contrary to a long line of court decisions, and, in my opinion, is contrary to the intent of those who drafted this bill. To the same effect are sections 306 (d) and (e) as they relate to reorganizations involving interest accumulations on securities.

The Missouri Pacific not only has substantial interest accumulations on its bonds, but, in addition, the dividend arrearages on its preferred stock now total more than $150 per share. Neither the bondholders nor the stockholders would vote for a plan under section 77 or under section 20b if securities distributed for interest and dividend accumulations were taxed as money received. In the absence of the assent of its securityholders the Missouri Pacific would be prevented from reorganizing and might be forced to stay in bankruptcy for a long time. The Missouri Pacific also is seriously affected by section 275 which provides that interest payments on income bonds cannot be deducted for tax purposes. Railroads are strictly regulated by the Interstate Commerce Commission not only as to rates that may be charged for service, but also as to the issuance of securities. The Commission has adopted standards which limit the respective amounts of fixed interest bonds and income bonds which may be issued. The income bonds approved by the Commission are true debt securities and have a fixed maturity date. Their issuance has been held by the Commission to be in the public interest because such bonds help railroads avoid bankruptcy if their earn