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ings are depressed from time to time. Thus, income bonds have been used in practically all railroad reorganizations in modern times. It is believed that over a billion dollars of income bonds are now outstanding. The railroad industry as a whole would be seriously affected if the present tax law were changed so as to deny the deduction of interest payments on these bonds for tax purposes. Such a denial would severely restrict, if not prevent, us from working out a plan of reorganization for the Missouri Pacific under section 77 or 20b. It is extremely unjust for one Government agency to restrict the amount of fixed interest debt that railroads can issue and for another Government agency sitting across the street to impose a tax penalty on railroads because they are prevented from issuing additional fixed interest debt. This is particularly true if the resulting tax penalty effectively prevents parties from working out an acceptable plan of reorganization.

The Missouri Pacific will also be adversely affected by section 309 which imposes a prohibitive penalty tax of 85 percent on the redemption of preferred stocks and income bonds. In plans of reorganization the Interstate Commerce Commission usually requires sinking funds for income bonds. Congress has declared that it is in the public interest for railroads to improve their financial structure by redeeming bonds and stocks in the market at a discount. This severe penalty tax imposed by section 309 on redemptions under mandatory sinking funds and on redemptions for the purpose of improving the financial condition of the company, not only is unjust, but is in contravention of a stated congressional policy.

Therefore, I urge you to carefully reconsider sections 275, 305, 306, and 309. Railroads are a regulated industry both as to rates and as to issuance of securities. Financing of railroads is subject to the careful scrutiny of the Commission and is permitted only if it is in the public interest.

It is my firm belief that the committee should provide a separate section for railroads comparable to those relating to reorganizations under chapter X of the Bankruptcy Act, changes to effectuate FCC policy, and exchanges in obedience to SEC orders. I wish to submit a new provision which I believe meets the objections outlined in this statement. I further wish to impress upon you that any new provision must be applicable to section 20b and section 5 of the Interstate Commerce Act as well as section 77 of the Bankruptcy Act. If section 20b is not included, then the Missouri Pacific by reason of any variance in tax treatment may be denied the benefits of proceeding under section 20b and, as such, would be forced to go through the long, arduous, expensive procedure under section 77 of the Bankruptcy Act. I respectfully request that you give the following amendment to H. R. 8300 careful consideration.

PROPOSED NEW SECTION TO H. R. 8300 RELATING TO INVOLUNTARY REORGANIZATIONS

UNDER THE JURISDICTION OF THE INTERSTATE COMMERCE ACT

KIND.

(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

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 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).

MEMORANDUM FOR THE SENATE FINANCE COMMITTEE REGARDING THE PROVISIONS

OF H. R. 8300, RELATING TO PROFIT-SHARING PLANS AND TRUSTS FILED BY COUNCIL OF PROFIT SHARING INDUSTRIES, APRIL 23, 1954

The Council of Profit Sharing Industries is a nonprofit association of employers in the United States and Canada who have established profit-sharing plans. Its purpose is to promote profit-sharing and good will and harmony among employees and employers and to provide a means of bringing together people who are interested in the profit-sharing movement. As of January 1, 1954, the council had 815 members, including such well-known organizations as Sears, Roebuck & Co. and Procter & Gamble, pioneers in the profit-sharing movement. As of that date there were 802,000 employees employed by members of the council. (A list of the members as of January 1, 1954, is attached hereto.)

The council appreciates the enormous task which has been undertaken by the Congress in revising the revenue laws of the country. There can be no quarrel with the proposition that a revision of those laws is a desirable thing. While the council does not presume to judge all of the provisions of the proposed legislation, it feels that there are some features concerning profit-sharing on which we can offer constructive criticism. It is in this spirit that the following recommendations are made.

SECTION 33 (C)-RETIREMENT INCOME

Subsection (c) defines retirement income for purposes of the credit against income tax allowed by section 38 of the proposed bill. Since profit-sharing distributions from qualified profit-sharing trust exempt from tax under section 501 (a) of the proposed bill are taxable to the employees as annuities under section 402 (a), they are probably within the purview of section 38 (c). Nevertheless, we feel that some change in language is desirable to put this beyond question.

We, therefore, recommend that section 38 (c) be revised to include "distributions from a profit-sharing trust exempt from tax under section 501 (a).”.

SECTION 101 (B) — EMPLOYEE DEATH BENEFITS

Under this section amounts up to $5,000 paid by or on behalf of an employer 'to the beneficiaries or to the estate of an employee by reason of the death of the employee would be excluded from gross income. Subsection (B) makes it clear that amounts distributed from an employees' stock bonus or profitsharing trust which is exempt from tax under section 501 (a) are within the exclusion, whether or not the employee's interest before his death was subject to forfeiture. However, this exclusion is made available only if the employee's total interest in the trust is distributed within a single taxable year of the distributee.

Since distributions under life insurance contracts and every other type of employee death benefit falling within this exclusion may be distributed either in one lump sum or in installments over a period of years, it is suggested that distributions to the beneficiaries of a deceased employee from a qualified employees' stock bonus or profit-sharing trust should be equally entitled to the exclusion whether made in one lump sum or in installments.

Presumably the objective of the section dealing with employees' death benefits is to place self-insured death-benefit plans, at least to the extent of the first $5,000, on a basis of equality with insurance plans. Application of the requirement for full distribution within a single taxable year to death benefits paid under profit-sharing and stock bonus trusts, but not to other death benefits, operates to defeat that objective.

The provisions of section 101 (b) as approved by the House of Representatives will tend to encourage and in some cases practically force the trustees of profitsharing trusts to make lump-sum distributions when the best interests of the

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widow or other beneficiary might well be served by smaller distributions over a period of years. Particularly for the widow of a low-income employee, it might be very undesirable to force upon her the making of decisions with regard to the investment or expenditure of a relatively large sum of money. The availability of the capital gain treatment afforded total distributions made within a single taxable year already provides an incentive for lump-sum payments. To add the further incentive of a $5,000 tax-free distribution would in many instances make it practically impossible for the trustees to exercise proper judgment as to the type of distribution which would be in the long-term best interests of the widow.

It is urged, therefore, that subparagraph (B) be revised to read as follows:

“(B) Nonforfeitable Rights. Paragraph (1) shall not apply to amounts with respect to which the employee possessed, immediately before his death, a nonforfeitable right to receive the amounts while living (other than amounts which are paid to a distributee by a profit-sharing or stock bonus trust which is exempt from tax under section 501 (a))."

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SECTION 402_TAXABILITY OF BENEFICIARY OF EMPLOYEES' TRUST

I

This section continues the present requirement of section 165 (b) of the Internal Revenue Code that the distribution be "within 1 taxable year of the distributee" if capital gain treatment is to be accorded to it. The council has long felt that this requirement presents a hardship in cases where the employee's services are terminated near the end of the calendar year, or under circumstances which give him a right to share in his employer's profits for the year in which termination occurs. In such cases there may not be sufficient time to compute the entire benefit due the employee before the end of the year or such computation is not possible because the employer's profits are not yet known. In many such cases, particularly where the employee dies leaving a widow, it is desirable to make a payment of the benefit due as quickly as possible even though the total amount of the benefit cannot be ascertained until the following calendar year. Yet if part of the benefits are paid in one taxable year and part in another, the capital gain rates do not apply. This seems to defeat the true intent of the statute.

The council, therefore, recommends that section 402 (a) (2) be revised to extend capital-gain treatment to cases where the total distribution is made within 1 year from the date of the event giving rise to capital-gain treatment.

If it should be felt that the opportunity to make distributions in 2 taxable years and still qualify for capital-gain treatment might open the door to abuses, perhaps a proper solution to the problem would be to modify the definition of "total distributions” so as to cover distributions of the total amount of the employee's interest in the trust fund determinable as of the date of the taxable event even though the participant may be entitled to . receive an additional distribution in a subsequent year, if such subsequent distribution represents only amounts attributable to the employer's contribution to the trust for a taxable year of the employer which ends after the separation from service.

At the same time it is recognized that the present rule of section 165 (b) of the Internal Revenue Code, which has been continued in section 402 (a) (2) of the bill, should not be abandoned entirely, but used as an alternative. Under some plans it may be possible that the lump-sum payment, though made within 1 taxable year of the distributee, is not made within a period of 1 year from the employee's death or other event giving rise to capital-gain treatment. Accordingly, in order not to affect those plans adversely, it is felt that the provisions of section 402 (a) (2) should be retained as an alternative.

II

In section 402 (a) (2) provision is made for capital-gains treatment for "any employee's trust described in section 501 (e) which is exempt from tax under section 501 (a).” This might be construed to deny capital-gain treatment to trusts which qualify for tax exemption under section 501 (a) by virtue of section 403 (c), since strictly speaking such trusts are not described in section 501 (e). Since this same problem arises in other sections of the new code, it might be best to include a provision in section 403 (c) to the effect that any trust which continues to be governed by section 165 (a) shall be deemed to meet the requirements of section 501 (e).

SECTION 501 (E) —EXEMPTION FROM TAX OF EMPLOYEES' TRUSTS

I

Nondiscriminatory classification

Paragraph (3) of this section sets forth acceptable classifications of employees to be covered by a qualified plan or trust and then prescribes limitations on those classifications in terms of the percentage of key employees covered and the percentage of regular employees covered. While the council advocates as broad a coverage as possible under a profit-sharing plan, it recognizes that as a practical matter there are many instances where coverage must be limited. The requirements of section 501 (e) are unduly restrictive and more stringent than the practices under existing law.

The apparent purpose of the section is to prescribe classes of employees which are acceptable without question. This is desirable but the proposed bill defeats this purpose when it applies the proviso of the section to all classes of employees described therein. It seems to us that the test laid down by the proviso has application only where a classification is set up by the employer which is not one of the classifications described in the statute or a combination thereof.

Moreover, the rules give no latitude to the employer who has a plan covering employees in a collective-bargaining unit who wishes to establish a plan covering employees not so situated. Nor do the proposed rules take into account in applying the percentage limitations employees who elect not to become covered by the plan. This often occurs where the plan is contributory.

Accordingly, we recommend two changes :
(a) The following classifications should be added to section 501 (e) (3):

“(vii) who are within a collective-bargaining unit;
“(viii) who are not included in a collective-bargaining unit;
“(ix) who are subject to the provisions of the Fair Labor Standards Act;

“(x) who are exempt from the provisions of the Fair Labor Standards Act;

"(xi) who qualify under any classification which is a combination of any of the classifications specified in clauses (i) through (x);

“(xii) who qualify under any other classification set up by the employer ; provided that not more than 10 percent of the participants in the plan are key employees, except that in the case of an employer having not more than 20 regular employees, such classification shall be acceptable if 50 percent or more of all such regular employees are participants in the plan and in the case of an employer having more than 20 regular employees, such classification shall be acceptable if 10 of such regular employees or 25 percent or more of all such regular employees, whichever is greater, are par

ticipants in the plan; Provided further, That not more than 30 percent of the contributions under the plan are used to provide benefits for shareholders. A plan shall be considered as meeting the requirements of this paragraph during the whole of any taxable year of the plan if on 1 day in each quarter it satisfied such requirement."

(b) The definition of "participants” contained in subparagraph (B) of paragraph (3) should be revised to include employees who are eligible to participate in the plan but who elect not to be covered thereunder and employees under a collective-bargaining unit which has rejected a plan offered to the unit by the employer.

II Ratio of contributions and benefits

Subparagraph (B) of paragraph (4) of section 501 (e) requires that 75 percent of the employer's contributions be so allocated that no employee receives greater benefits, as a percentage of compensation, than any other lower-paid employee. The other 25 percent can be allocated in any manner desired as long as no employee receives more than twice as much, as a percentage of compensation, as any other lower-paid employee..

Under present law the Commissioner of Internal Revenue also requires correlation between benefits and compensation. This correlation is tested by classifying the employees into salary groups. The benefits allocated to the highersalary groups as a percentage of compensation cannot be substantially greater than the benefits allocated to the lower-salary groups.

The rule required under the proposed law is more rigid, as it does not provide for a grouping of employees in testing whether there is discrimination. Instead, the test is applied in terms of individual employees. Thus, if there is one highly compensated employee who does not meet this test, the whole plan will be disqualified. In view of this, our first recommendation is that any test that is devised should be applied to groups or classes of employees rather than individual employees.

Second, the rule set out in section 501 (e) (4) (B) uses only compensation as a measuring stick for determining employee benefits. It does not take into consideration the fact that benefits under many employees' trusts are related not only to compensation but also to other factors, such as years of service or age of the employee. Such methods of determining benefits are desirable in view of the fact that the major purpose of an employees' trust is to insure that a re tiring employee will have ample security to allow him to live comfortably for the rest of his life. By giving greater proportionate benefits to older employees, or those with greater seniority, their retirement security is being enhanced However, the rule under section 501 (e) (4) (B) would not permit such a method of allocating benefits except to a very limited extent.

We do not mean to say that compensation should play no part in determining the empolyees' benefits. For example, we do not believe that one employee should receive a substantially greater percentage of benefits to compensation merely because he is in a high salary bracket. On the other hand, where years of service weigh quite heavily in the calculation of benefits, a highly compensated employee should get the same percentage of benefits as any other employee with the same number of years of service, even though it may be more than twice what some other more recently hired employee receives.

We are not submitting with this paper a proposed amendment to this code section. Instead, we request recognition of these two principles :

(1) Any test that is devised to test discrimination in the allocation of the company contribution should be applied to groups of employees rather than individual employees.

(2) At the present time the benefits provided by many employees' trusts are determined on a basis other than compensation. The test for discrimination in the allocation of the company contribution should, therefore, not be based strictly on benefits as a percentage of compensation.

III What constitutes compensation

Section 501 (e) (4) defines the term "compensation" for the purposes of that section. Such a definition is necessary because of the limitations which the section sets out with regard to the benefits which employees may receive in relation to their compensation. This definition of compensation includes the employee's regular rate of compensation plus any other compensation which is determined under a definite formula. However, it does not include such items of compensation as discretionary bonuses paid to employees each year. Many companies pay such a bonus, and the amount paid is often determined by such factors as the profits of the company and the merit of the individual employee, etectra. Moreover, the practice has been to recognize such discretionary bonuses where they follow an established pattern or are averaged over a 3- or a 5-year period.

It would seem that the method of determining compensation should not be of import in determining the amount of benefits a member of an employees' trust should receive. It would seem more desirable that the term "compensation" include all taxable compensation paid to the employees, including the amount of any discretionary bonus not computed by means of a definite formula.

SECTION 403— DEDUCTIONS FOR CONTRIBUTIONS OF AN EMPLOYER Section 403 (a) (4) permits a deduction to the employer for contributions to a trust which would qualify for exemption under section 501 (a) except for the fact that it is organized outside of the United States. This paragraph recognizes the need of a deduction for contributions to employees who are working outside of the United States. However, it does not meet the problem arising when an employee who is participating in a domestic trust is sent abroad to work for a subsidiary or affiliated corporation. In such a case the employee will not receive full benefit from the trust unless the domestic employer is permitted to make contributions to the trust during his absence.

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