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that certainly no more than 1 or 2 percent of our entire export goes to the foreign buyer for his personal or household use (as opposed to commercial or industrial use or for resale). This fact is significant because a "retail establishment,” as the term is interpreted by the Bureau of the Census, by the Bureau of the Budget, by the Social Security Board, under the Wages and Hours Act, and by "governmental usage” in general (Roland v. Walling, 326 U. S. 657 at 674), is consistently held to be identified on the basis of whether or not it sells goods for “personal or household consumption," rather than “for resale, or to commercial or industrial customers.” Under this definition of the term “retail,” what American goods moving abroad are the subject of “wholesale" rather than "retail” sale? Any company within the broad group of construction equipment or industrial goods manufacturers, for example, which has permanent establishments (including a stock of goods) in countries in the Eastern Hemisphere will receive no tax benefit under these sections, regardless of its investment abroad. Consider a machine-tool company with branch offices in France: no matter what it does by way of selling activity there, regardless of its investment in the vital distribution end of its European business, it will receive no tax advantage under these sections. It is true that the “permanent establishment” will be there, sales employees and servicemen may be hired, but there will be no benefit under sections 923 or 951.
A short time ago it was said on all sides that intelligent tax legislation was vitally needed to stimulate American trade and investment abroad. The sections of the present bill clearly cannot have the result of "stimulating” American trade as they in fact discourage the great bulk of it which passes in wholesale selling out of the United States. Perhaps it is within the view of its framers that the act will stimulate investment in “retail establishments,” thus encouraging American industry to invest moneys in that direction. If that is its object, then those in American business who have ventured forth already to invest dollars in wholesale distribution abroad have been badly deceived by earlier governmental overtures toward encouraging foreign investment. There are figures on the value of direct United States investment in foreign countries, both by area and by industry. Fortunately, these figures were compiled keeping in mind the difference between “wholesale” and “retail" distribution. These data show that in 1950 there was a direct United States investment of $541,600,000 in wholesale distribution facilities abroad; at the same time only $220,600,000 in retail trade facilities had been invested. Thus, most of those who have made the “dollar investment abroad” that Congress has talked about since 1946 will not stand to benefit from the proposed legislation.
But will this section stimulate investment abroad? America is great because of its ability to produce and sell quality machinery and equipment in large quantity. Quantity with quality arises where sales mount. To have sales mount, as those with even limited business experience know, you normally have to have a number of outlets-dealers or distributors, as they are called. These sales are the initial step in creating conditions favorable for additional American investment in foreign countries. Yet, paradoxically, it is these very sales to dealers and distributors which sections 923 and 951 rule out from tax benefits. If creation of local selling agencies in the retail field abroad is the goal of these sections, the concept runs contrary to the sum total of the experience and history of American business.
B. “Factory.”—It is apparently considered by the framers of sections 923 and 951 that reducing the income tax on income derived from a “factory" abroad fulfills the role of "stimulating" investment abroad. Let us look at a concrete situation : It cost X Co. $50,000 last year to set up a Swedish oil pump plant; even then it ended up owning only one-half of it. X Co. makes lathes, milling machines, hydraulic pumps, and a variety of other machines and equipment at different points in the United States. A plant to manufacture one-fifth of X Co.'s whole line of products abroad would cost well over a million dollars, considerably more than it can afford at this time. X Co. also sells goods abroad through its own employees and dealers in different foreign countries. Result: Under the present sections 923 and 951, X Co. is to be commended for investing $50,000 abroad, but no tax credit will be made available to it unless it discontinues selling abroad the goods manufactured by it in the United States. Tax credit will be substantiated only if it restricts itself to the sale of the fuel units manufactured in Sweden, a negligible portion of the X Co. line.
Again, company Y’ is in the wholesale drug business. In all countries it is
1 Statistical Abstract of the United States for 1953, p. 885, table 1046. 2 Actual example,
compelled to meet certain high standards of product performance to be permitted to sell goods. Company Y operates a plant in France, manufacturing perhaps one dozen different drug products. It sells, in Europe and Africa, these products plus some 1,000 other and different products which, for reasons of quality and production control, are best and most economically manufactured in the United States. Result: Company Y enjoys no tax credit for goods thus sold abroad, even though it has a “factory,” or, as is the case, factories, situated abroad. Neither trade nor investment has been stimulated.
The requirement of operating a "factory” is an insurmountable obstacle in many of the countries of the world. Before there can be a factory, there must be a demand for the goods which the factory can produce; there must also be an ability on the part of many of the people of that community to purchase the output of the factory. Road-building equipment has sold well in the Belgian Congo in the last few years; it sold in French West Africa in large quantities before that. The framers of these sections would surely not urge American industry to build a factory there. They would not urge a machine-tool company to build a plant in India. Yet they must certainly say that it is desirable and stimulating to United States trade (and eventually investment) to have American industries sell in these areas. The fact is that a concentrated and prolonged selling effort must precede factory activity in most of these areas, areas which are not yet ready for the industrial era which we have experienced. But under sections 923 and 951, no tax benefits are offered to United States companies which are willing to establish and operate the fundamental selling agencies in these outposts. They must first have a "factory” before they can enjoy the encouraging tax rate.
It has authoritatively been further advanced that an assembly plant does not constitute a “factory” within the meaning of these sections. Clearly, agricultural operations are not included within the classification. Perhaps there is a valid, if not apparent, reason for discriminating against these groups.
Unfortunately, the other industrial countries of the world have not adopted the same tax encouragements toward their foreign industry that we have toward ours. The result: international competition now has attained such intensity that it has already forced American production out of many major world markets. It promises to become even more destructive in the immediate future. III. Considerations surrounding suggested revision
The framers of sections 923 and 951 are quite properly anxious to exclude from tax benefits those companies which risk no capital, have no office, and carry on no bona fide business activity abroad. The wish to exclude these marginal operators, however, has deprived the great bulk of legitimate American business, having establishments abroad, of any tax advantage. Suggested revision of these sections must exclude, therefore, the fringe operators whose existence has been responsible for the unfortunate wording of the present sections. These companies should be compelled to establish a bona fide branch office abroad from which business activities must emanate. Such activities should properly contemplate the hiring of full-time employees within the foreign country to carry on business actively there.
The exclusion from the term “trade or business” of offices or agents to import or facilitate the importation of goods abroad is, as now worded in the bill, entirely appropriate to further insure that fringe exporters do not participate in the tax benefits which should be extended only to those willing to take the added risks of doing business abroad. IV. Specific recommendations
It is specifically recommended that,
(1) the term “retail establishment” appearing in sections 92 (a) (3) (A) (ii) and 951 (a) be deleted, and the following language inserted : "bona fide retail or wholesale establishment directly engaged in commercial activity”;
(2) there be added to subparagraphs 923 (b) (1) (A) and 951 (b) (1) (A), following the word “merchandise," the following restriction : "unless such establishment is a permanent one having bona fide employees directly engaged abroad in its business activities on a full-time basis."
The above and foregoing report and recommendations are respectfully submitted this 7th day of April 1954.
BAKER, MCKENZIE, HIGHTOWER & BRAINERD,
Attorneys at Law. The CHAIRMAN. Mr. McGregor. Sit down and make yourself comfortable and identify yourself to the reporter.
STATEMENT OF FRANK R. MCGREGOR, EXECUTIVE VICE PRESIDENT,
COUNCIL FOR INDEPENDENT BUSINESS
Mr. McGREGOR. Mr. Chairman and members of the committee, my name is Frank McGregor. I am executive vice president of the Council for Independent Business, which is an organization which represents small independent business. I also operate a public relations businessSenator FLANDERS. Independent of what?
Mr. McGREGOR. It means it is not part of a large-like it wouldn't be a subsidiary to General Motors.
Senator FLANDERS. Are you independent of NAM, for instance?
Mr. McGREGOR. Our organization is a completely separate, independent organization. Yes, we are.
I also operate a public-relations business, of which I am the head. I am on the board of directors of a couple of other corporations also.
Small and independent business men and women in this country who operate in whole or in part under the protection of our patent system are very much alarmed because of section 1235 of this tax bill. If enacted into law, it would operate to practically deny an inventor any chance to profit from his patent as a capital asset.
I do not intend to read this provision here, because you gentlemen are familiar with it.
You will perhaps remember that the tax bill of 1950, H. R. 8920, contained a provision that “a patent or copyright; an invention or design” could not be held or sold as a capital asset while it was "held by a taxpayer whose personal efforts created such property."
You will also remember, probably, that Mr. C. È. Earle, now deceased, and I appeared before your committee to urge the deletion of that provision and that this committee did cause that provision to be stricken from the bill. The Senate so voted and the House conferees concurred and the bill was so passed.
I submit to you that the section I have referred to is in effect the same philosophy dressed up in different words. Let us not be deceived by the 5 years alloted to the inventor to collect payment for his invention under a capital-gains status. It is common knowledge that inventors do not as a rule have the money to develop, merchandise, and practice their patents. In order to profit from his patent the inventor must either sell it or license its use-usually an exclusive license which the courts have held is equivalent to a sale.
There are very few, if any, inventors who get any recovery within the first 5 years after the issuance of a patent. It is easy to see that the inventor would collect little or nothing during the 5 years the patent was being developed and would then be in the melancholy position during the remaining 12 years of the life of the patent of watching the purchaser of his patent reap the harvest of the inventor's creation. The result, then, would be the same under this provision as it would have been under the provision which your committee struck out 4 years ago.
Let me give you an example that I happen to know about. In 1942 a chemical engineer, after working in his basement for a period of about 18 years, developed a process of combining lithium with lubricating grease. This gave the grease a viscosity heretofore unknown and enabled our planes in World War II to take off from airbases in the South Pacific in temperatures of 100° or higher and fly into high altitudes where the temperature is as low as 40° below zero, without the lubricating grease becoming thin as water in the hot temperature or solidifying into a mudlike consistency in the cold temperature.
The process is equally valuable for trucks and automobiles and it is in wide use in industry today. This is one of the very few cases where an inventor sold his patent for $1 million, as the patent was sold to a company that specializes in buying and developing patents for something in excess of that amount payable over the remainder of the life of the patent and based on the anticipated earnings from it.
But let us see how the inventor would have fared under section 1235. The first 5 years, there were no profits or royalties to the inventor. The second 5 years the patent earned around a total of $170,000, of which the inventor received a part. The patent now has 5 years to run and, based on the rate at which the lithium grease is increasing in use in industry, it is estimated that the patent will, during that time, earn well over the million dollars to be paid to the inventor. It will be seen that if section 1235 had been in effect when this patent was obtained, the inventor would have received absolutely nothing for his very important contribution to our national defense and welfare; while the purchaser of the patent would have made well over $1 million on which he would have had to pay only a capital-gains tax.
This case is exceptional only in the fact that the patent will earn such a large sum of money. Most inventors do not achieve anywhere near this high figure for their patents. In fact, not 1 inventor in 100,000 ever gets within hailing distance of $1 million.
We Americans believe that the great advantage our economic system has over the Communist philosophy is that we operate under an incentive philosophy whereby a man profits in accordance with his contribution to the wealth of the Nation. This, we believe, is the motivating force which has spurred our people on to make us the greatest industrial Nation on earth.
It is a fundamental belief then in this country that a man who creates wealth for this Nation by inventing something new and useful should be rewarded by society for that contribution. The idea that a bill could be passed depriving the inventor of a large part of the fruits of his labor is so foreign to our conception of what is right and fair, that the American people just cannot believe it could happen here. None of us can understand the philosophy behind the type of thinking that has injected such limitations into this bill.
The Founding Fathers believed so strongly in the importance of rewarding the creator of new things, that they put it in the Constitution. As a matter of fact, during debates on the Constitution, this was one question on which there was no argument. Everybody agreed that we should have a patent system. We had the first patent system in the world. Up to that time it had been granted by monarchs as a monopoly, or the law had to be passed in the colony to get a patent, in the respective colony or State.
Article I, section 8, of the Constitution declares: The Congress shall have the power to promote the progress of science and useful arts, by securing for limited times to authors and inventors, the exclusive right to their respective writings and discoveries.
And the Congress of the United States has exercised this power to the great benefit of the people of America by setting up a patent system for this purpose. Now, it appears there are those who want
, us to turn our backs upon the philosophy of the Founding Fathers and penalize inventors, rather than reward them.
Let there be no doubt as to who is the target-for, it says, and I quote, "a patent *** (held by)”—the parentheses are mine—“any person whose efforts created such property.” This applies, then, to the creator of the invention.
Under this provision, the man who buys an invention from the inventor is privileged to treat it as a capital asset. If, after buying a patent from the inventor, the money man sells it at a fat profit, he can take advantage of the capital-gains tax set forth in this act. In other words, the entrepreneur who buys a patent can treat it as a capital asset, but the man who created the patent by his own thinking and personal efforts is prohibited from so doing, unless he collects his payment in the first 5 years—if, indeed, there is any money to collect during that 5 years.
None of us can understand how a patent, a piece of property which is not held for sale to regular customers in the ordinary course of business, can be in one man's hands a capital asset, yet in another man's hands not a capital asset—and perhaps I should interject here that we are not talking about professional inventors who make a process of inventing things and selling them. We are talking about the man who is an engineer, who is conducting an engineering business, and works nights and invents something; Or, a doctor who invents a new operation and writes it up, and then, if he collects money, he has to pile what he collects on top of his income, and it leaves very little for the work he has done. So he has no incentive to do it.
Our patent system is responsible, to a large degree, for the tremendous and rapid growth of the industrial phase of our economy. Although the individual inventor has rarely been properly rewarded for his advanced thinking, vision, and personal efforts, he deserves the major part of the credit for this great progress. His type of thinking should be encouraged rather than discouraged.
Invention does not thrive on adversity. The old notion that great discoveries are made by starving geniuses in a garret is romantic, but it is just not true. Invention increases as the prosperity of the country increases, and it fades and diminishes in bad times and during war periods.
Attached hereto is a graph entitled "Trend of Inventive Thinking in the United States, 1840-1951."
It shows graphically the effect of depressions and wars on our inventive capacity. It also shows the trend of our inventive ability during the last 90 years.
The graph is based upon the annual number of patent applications for each 10,000 of population in the United States. It also shows patents granted and the relationship between the two. For example, we see that toward the close of the 19th century, when the population was from 60 million to 70 million, patent applications ran as high as 612 for each 10,000 of population, falling off, of course, during the depressions or “panics"—as they were called then-of the eighties and nineties.