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Another possible solution would be to permit the taxpayer to deduct in 1954 the tax which applies to that year despite the fact that this tax was also deducted in 1953. Since only 1 year's tax would be deductible in any 1 year, it makes little practical difference whether the 1954 deduction represents the tax applicable to that year or the tax based on an assessment date which falls in that year. Many taxpayers in the past have changed their accounting practice to deduct property taxes in accordance with the requirements of rulings and court decisions rather than in the period to which the taxes are generally considered to apply. In connection with this transition, up to a full year's property-tax deduction has been completely lost, although a full year's property tax was paid in every year. For example, in computing 1941 income there might have been substituted for the tax applicable to the year 1941 the tax which applied to the year 1942 which was based on a 1941 assessment. The tax applicable to the year 1941 would not have been deducted in any year inasmuch as the 1940 deduction would have represented the tax applicable to 1940 based on the 1939 assessment. The taxpayer was not particularly concerned with this theoretical loss of a year's deduction because he had a property-tax deduction in each year and it made little difference whether for any year the deduction represented the tax based on assessment in that year, or the tax which applied to that year based on assessment in the preceding year.
For the same reason, the Government should not be particularly concerned that a specific tax is deducted in more than 1 year as long as only 1 tax is deducted in each taxable year. Revenues are not affected.
Another point which deserves consideration is the fact that section 461 (c) as written applies only to real property taxes. There would seem to be no reason why the same principle should not be made applicable to personal property taxes or any other taxes which relate to a definite period of time.
SECTION 462. RESERVES FOR ESTIMATED EXPENSES
Section 462 is a very important step toward the conforming of tax accounting to generally accepted accounting principles. It is assumed that in the year when a reserve for estimated expenses is first taken into account in computing taxable income, the taxpayer will be able to deduct, in addition to the reserve provision, the actual expenses incurred during the transition year; i. e., that the taxpayer will not be required merely to substitute the reserve provision for the deduction of all or a part of the actual costs and expenses which would have been allowed under present law.
To take a very simple example, assume that: 1. Cash discounts allowed in 1954 with respect to 1953 sales amount to-- $10,000 2. Cash discounts allowed in 1954 with respect to 1954 sales amount to-- 100, 000 3. Cash discounts to be allowed in 1955 with respect to 1954 sales are estimated to amount to--
12, 000 Section 462 would permit the taxpayer to establish a tax-deductible reserve at the close of 1954 in the amount of $12,000 (item 3 above). The question is, however, as to the amount of deduction for cash discounts which the taxpayer will be permitted to claim for the entire year 1954. Would it be $122,000, the sum of all three of the amounts listed above, or would it be only $112,000, the sum of items 2 and 3. The allowable deduction for the transition year should include item 1 inasmuch as no previous deduction has been allowed with respect to this item. It is conceivable, however, that regulations might provide that only items 2 and 3 are allowable deductions in the transition year since only these items relate to 1954 sales.
Under present law when a taxpayer is permitted to change from the actual loss method to the reserve method of deducting bad debts, he is allowed to deduct actual losses during the transition year as well as the provision for future losses. The same rule should apply under section 462, but it would be highly desirable to spell this out in the statute.
SECTION 172. NET OPERATING Loss DEDUCTION (DIVIDENDS RECEIVED CREDIT)
One of the basic principles of our system of taxation is that double taxation is to be avoided wherever possible. Recognizing this principle, the Internal Revenue Code, provides for a credit against net income of 85 percent of dividends received by one corporation from another. A provision of similar import has been contained in all the revenue acts as far back as 1917. The purpose of these provisions is and has been to eliminate double taxation of corporate earnings prior to their distribution to the individual shareholders. (H. R. 8300, the Internal Revenue Code of 1954 bill, would extend this principle of the elimination of double taxation even further, by granting certain exemptions and deductions to individuals with respect to their dividend income.)
Another basic principle of our system of taxation is that taxpayers which are equally situated are to receive equal treatment for income-tax purposes. Recognizing this principle, the Internal Revenue Code provides for a net operating loss deduction under which the taxpayer is allowed a 7-year period within which to offset the loss of 1 year against the income of other years. This provision is intended to provide assurance that the same aggregate income tax will be paid on the same aggregate net income earned over a period of years, whether it is the result of several years of steady profits of flows from the uneven pattern of both profit and loss years.
Under existing law, however, a corporation which receives dividend income and also suffers a net loss from operations in some years finds that these provisions, far from giving the relief for which they were enacted, actually result in the imposition of a double tax on the dividend income, and that the corporation having some loss years may pay more taxes on the income earned over a period of years than would be paid by another corporation earning the same income over the same period, but having a profit in each of those years. H. R. 8300 attempts to give at least partial correction to this inequitable and chaotic arrangement, but the provisions of that bill fall far short of the relief needed. The provisions of this bill will be considered in more detail later, but in order that they may be understood, it is necessary first to examine in more detail the provisions of existing law.
Under present law corporations which receive dividend income include the full amount of these dividends in their gross income. Pursuant to the provisions of section 26 (b) of the code they are permitted to take as a credit against net income 85 percent of the amount of these dividends. In other words, it is the general intent of this section that taxable income should include only 15 percent of the amount of dividends received. The same provision of the code, however, limits the credit for dividends received to 85 percent of net income. Consequently, in a loss year, when there is no net income, a corporation is entitled to no dividends-received credit. The full amount of dividend remains in income without any offset. Under present law, a net operating loss is defined to be the excess of deductions over gross income. Under such a simple and restrictive definition, it is at once apparent that no allowance is made therein for any dividends-received credit on the part of a corporation suffering a loss. Consequently, the corporation cannot have an operating loss under the present statute unless its deductions exceed its gross income computed by including therein 100 percent of the dividends received in the year of the loss. This definition of the net operating loss is of crucial importance in the matter with which we are dealing, since it is the net operating loss which must be carried over to another year as an offset against the income of that year, in order to determine the average income for the period upon which the taxpayer will ultimately pay income tax. Bearing this principle in mind, it is to be seen that while the corpo ration with a history of steady profits includes as income and pays tax upon only 15 percent of the dividends which it receives, a corporation which has suffered a loss and which is seeking tax equality under the net operating loss provisions by averaging the income of its profit and loss years, must include in income, and pay tax upon, 100 percent of the dividends received in the loss year. Clearly, this result frustrates to a great extent the policy of the net operating loss provisions.
As an illustration, let us suppose that each of 2 corporations receives $1 million as dividend income in a particular year. Corporation X makes a profit in that year, whereas corporation Y sustains a loss. Since corporation X has net income, it may take as a credit against that net income 85 percent of the dividends it has received, and pay tax only upon the remaining 15 percent. At the
current 1952 present rate, this would mean that corporation X would pay a tax of $78,000 on $1 million of dividends. Corporation Y on the other hand, since it has sustained a loss, is entitled to no dividends-received credit, with the result that ultimately, through the use of the net operating loss provisions, it must pay a tax upon the full amount of the dividend income, totaling at present rates, $520,000. In other words, the corporation with the loss pays $442,000 more in tax than is paid by a corporation with steady profits, upon the same amount of dividend income. The injustice of such a situation is clear, and should be remedied by appropriate legislation.
The discrimnation under existing law against a corporation receiving dividends and suffering a loss extends still further. Let us assume by way of explanation that corporation Y, in the previous example, has determined its operating loss and now desires to offset that loss against the income of another year. Let us assume further that the net operating loss so computed amounts to $850,000 and that the income of the year against which the loss is to be offset amounts to $2 million of which $1 million has dividend income. Under present law, the net operating loss must be reduced by the amount of the dividends-received credit applicable to the profit year to which the loss is carried. Under the example, the dividends-received credit applicable to the $1 million dividend income would be $850,000. Since the net operating loss is the same amount, $850,000, it is completely wiped out by the dividends-received credit in the profit year. From another point of view, the dividends-received credit in the profit year is entirely forfeited. In other words, the loss corporation has given up its credit not only in the loss year, but also in the profit year to which the loss was carried.
H. R. 8300 would provide partial relief from this unjust and illogical situation. Under the provision of that bill, it would no longer be necessary for the loss corporation to forfeit its dividend received credit applicable to the profit year to which the loss is carried. In the committee report, at page 27, the House Ways and Means Committee notes that this provision would “lessen the differences in tax treatment of firms with fluctuating and those with stable incomes." Thus, the committee has recognized that discrimination exists under present law. It recognizes further that it has not removed this discrimination, but is only attempting to grant partial alleviation. It is submitted that there is neither logical reason nor justifiable excuse for the continuation of any part of this discriminatory treatment, and it should be moved in its entirety. The situation could be easily and completely corrected simply by converting the present dividends received credit into a fully allowable deduction.
Under present law, the taxable status of a corporation receiving dividends depends upon whether it makes a profit or sustains a loss, with a severe penalty placed upon the corporation unfortunate enough to sustain a loss. This is contrary to our whole system of taxation. If the profit corporation is entitled to a deduction for its dividend income, a loss corporation has an equal right to such a deduction. Indeed, it would seem that the equities should be in favor of the loss corporation, since that corporation is more greatly in need of favorable tax treatment in order to regain its place in the economic community. With the continuation of existing high rates, the full availability of a loss carryover is essential. A business with fluctuating income cannot hope to survive unless there is available some method of averaging its income over an extended period of years, to the end that it shall be placed in an exactly equal situation taxwise with the corporation with a steady level of income.
The net operating loss provisions can and should afford a means of providing a strong and economic incentive during periods of decreased business activity; in the face of declining profits it is unreasonable to expect business to go forward with expenditures for maintenance and expansion of its plant, or to keep employment at a high level, measures which are necessary on the part of all to maintain a stable and dynamic economy, unless it is assured that any losses which may be suffered can be fully offset against the taxable profits of other years. Otherwise, a company may be compelled to curtail such expenditures at a time when inaction would be most harmful to the country as a whole.
It is therefore recommended that,
1. The dividends received credit allowable under existing law should be converted into a fully allowable deduction from gross income.
2. The deduction for dividends received authorized by H. R. 8300 should be made fully allowable from the gross income of the taxpayer, without regard to the existence or absence of net income.
The first recommendation would require the following amendments to the Internal Revenue Code:
Add to section 23 of the code the following new subsection :
"(gg) DEDUCTION FOR DIVIDENDS RECEIVED BY A CORPORATION.-In the case of a corporation, 85 percent of the amount received as dividends (other than divi. dends described in section 26 (b) on the preferred stock of a public utility) from a domestic corporation which is subject to taxation under this chapter."
Section 26 (b) should be amended technically to remove the present subsection (1) which now allows a credit for dividends received from domestic corporations.
To accomplish the second recommendation, H. R. 8300 should be amended as follows:
Amend section 172 (d) (5) to read :
“(5) SPECIAL DEDUCTION FOR CORPORATION.-No deduction shall be allowed under part VIII (except sec. 243 (a) and 248) or under section 922 (relating to Western Hemisphere trade corporations).” Amend section 246 (b) by deleting therefrom the first reference to section 243. (The following letter was subsequently received for the record :)
NATIONAL ASSOCIATION OF MANUFACTURERS,
New York, N. Y., April 23, 1954. Hon. EUGENE D. MILLIKIN, Chairman, Committee on Finance,
United States Senate, Washington, D. C. DEAR SENATOR MILLIKIN : At the time of testifying before your committee on April 21, our subcommittee on taxation of foreign income under the chairmanship of Mr. Malcolm G. Stewart, general counsel of the Gillette Co., Boston, Mass., had not completed its analysis of the relevant sections of H. R. 8300. ACcordingly, I did not go into our current policy in this area, although, as quoted below, it was included as item V (j), of our specific recommendations attached as exhibit A.
“The reduced tax rate now afforded to Western Hemisphere business income should be extended under similar terms and conditions to business income from all foreign sources."
Yesterday this subcommittee met and developed the attached implementing statements on specific sections, which I hope may be included in the record as additional exhibits to my testimony. Also attached are two additional statements dealing with other sections of the bill which I likewise hope may be included as exhibits. I will be most grateful if you would extend to us this further courtesy. Sincerely yours,
FRED MAYTAG, Chairman, Committee on Taxation.
BUSINESS INCOME FROM FOREIGN SOURCES
SECTION 951. INCOME WHICH MAY BE DEFERRED The association's policy on taxation of income from foreign sources, as adopted by its board of directors on April 14, 1954, on recommendation of its taxation committee, reads as follows
“The reduced tax rate now afforded to Western Hemisphere business income should be extended under similar terms and conditions to business income from all foreign sources."
H. R. 8300, in its present form, falls far short of implementing this policy, which has been recommended by many other groups as well. By way of illustration, the bill, as now written, excludes from the 14-point credit all wholesale business conducted outside the United States without regard to whether the articles sold or distributed originated outside the United States, or are sold or distributed by the manufacturer or others, and regardless of the fact that there may be substantial investment in a foreign country or countries.
SECTION 954. DETERMINATION OF WITHDRAWAL OF BRANCI INCOME Under section 954, it should be made clear that, in the case of a corporation organized in the United States and engaged in carrying on an eligible trade or business in a foreigu country, all of its assets and liabilities will be elected branch assets and liabilities, res ctively, if aud to the cxtent acquired or incurred, as the case may be, to establish or operate its business in such foreign country.
SECTION 904. LIMITATIONS ON CREDIT The limitations on foreign tax credit provided in section 904 should be amended to allow the taxpayer to elect annually whether per country or overall limitation shall apply.
SECTION 923 (A) (3) (A) (III). SALE IN UNITED STATES It is recommended that articles or products for further manufacturing or processing be excluded from the limitation imposed by section 923 (a) (3) (A) (iii).
SECTION 923 (A) (3) (B) (1), OWNERSHIP PERCENTAGE The percentage ownership in section 923 (a) (3) (B) (i) should be reduced to 10 percent to correspond with present ownership percentage for allowance of a foreign tax credit under the "tax deemed paid" provision. As a minimum alternative, the provision should not require more than the lesser of (1) 50 percent of the voting stock, or (2) the maximum percentage permitted under foreign law.
SECTION 921. DEFINITION OF WESTERN HEMISPHERE TRADE CORPORATIONS
It is believed that the present Treasury position regarding incidental purchases of Western Hemisphere corporations is inconsistent with the intent of section 109 of the 1939 Internal Revenue Code, and it is recommended that reference to such purchases in section 921 of H. R. 8300 clearly state that purchase of materials for the purposes of the trade or business, regardless of where purchased, should not disqualify a corporation from the definition of a Western Hemisphere corporation.
SECTION 921 AND SECTION 923 (A) (3) (A). DEFINITION OF GROSS INCOME
When defining gross income, there should be excluded therefrom the proceeds of insurance covering any properties outside the United States, its territories or possessions.
SECTION 1237. DEALERS IN REAL PROPERTY
Section 117 (N) Internal Revenue Code now extends to dealers of securities the possibility of capital asset treatment for securities which they may hold as