Revenue Service woud readily reach an agreement if the situation were not complicated by the position which the agent is taking with respect to goodwill. I have referred to the position as taken by the agent; actually the matter is now in the hands of the engineer in charge of the New York division of the Service, and I will refer hereafter to "the representatives of the Service." The representatives of the Service have taken the position that Circle acquired goodwill which had a value of many millions of dollars, and they have made various alternative computations of the value of the goodwill which they claim was acquired, the amounts ranging from $3,268,000 to $4,561,705. As I have already stated, the contract under which Circle acquired the assets and business of its predecessor excluded any goodwill. The representatives of the Service contend that nevertheless goodwill was acquired. I do not want to stress this particular issue, because if it were the only issue, we could obtain a decision on it in the Tax Court wihout too much difficulty. Furthermore, I do not believe that the effect of that particular provision of the Circle contract is a matter of general interest. The point I do want to emphasize is that the claims advanced by the representatives of the Service bring out most effectively that the disallowance under the code of any amortization for purchased goodwill is directly responsible for controversies between the Internal Revenue Service and taxpayers for which there is no need and which are of a kind that it is highly desirable to avoid. The reason why the Service has claimed that Circle acquired goodwill having a value of $3,268,000 to $4,561,705 is on the theory Circle acquired assets worth several million dollars more than what it paid; the excess must be prorated among the items acquired (other than the net current assets); and such a proration would produce mathematically a very large reduction in the amount considered to have been paid for plants and equipment, which are depreciable. In other words, the larger the part of the total purchase price of $20,500,000 which can be treated as having been paid for goodwill, in respect of which amortization is not allowed, the smaller the portion which will be treated as having been paid for the plants and equipment, on which depreciation is allowed. Applying the proration procedure, previously discussed, to the minimum figure of $3,268,000 attributed by the Service to nondepreciable goodwill, plant and equipment would be taken over at $3,843,531 (instead of $794,172) less than their appraised value of $10,320,903. If it could be assumed (1) that goodwill was acquired, (2) that the value of the goodwill could be determined or estimated with some reasonable degree of accuracy, and (3) that the value of any goodwill was permanent, rather than temporary, no one could complain. I do not think any of those three assumptions can be made as to the Circle acquisition and there are countless other cases where they cannot be made. I want to emphasize particularly that the failure to allow amortization for purchased goodwill seems inevitably to lead the Service to contend that goodwill was acquired and to make the most extreme and controversial contentions about the value involved. When, as in the case of the Circle acquisition, a lump sum is paid for all of the assets of a going concern, there ought not to be too much difficulty about allocating the total purchase price among the assets acquired. In the case of the Circle acquisition, for example, except for the controversy about goodwill, it is necessary to consider only (1) net current assets, (2) land, and (3) plants and equipment. There has been no controversy about the value of the net current assets which were acquired by Circle. Appraisals of land and plants and equipment even by professionals may produce controversies, but they follow familiar lines. A controversy about the value of goodwill is another matter. If, as in our case, (1) the transferor company does not carry goodwill on its books, and (2) the contract of purchase of the business does not provide for any payment for goodwill, there is nothing to which the Service can tie any valuation of goodwill which it claims has been transferred. By the same token there is virtually no limit on the amount which the Service may claim as the value of the goodwill that is asserted to have been transferred. IV. THE 1954 CODE, AS AMENDED, ALLOWS AMORTIZATION OF CERTAIN INTANGIBLES; PROPOSED AMENDMENT WOULD ELIMINATE DISCRIMINATION Section 177 of the code, which was enacted in 1956, permits of amortization of expenses incurred in the acquisition, protection, and expansion of trademarks over a period of 60 months (this provision is not applicable, as yet, to purchased trademarks). Trademarks theretofore were not accorded this treatment because their useful lives, as in the case of goodwill, were not definitely determinable. The Congress has thus recognized the principle that certain intangibles should be amortized although their useful lives are not definitely determinable. It has set a period of not less than 60 months during which these intangibles may be amortized. Manifestly, it is discriminatory for the Internal Revenue Code to disallow a tax deduction for amortization of purchased intangibles while allowing a deduction for the expenses of protection and expansion of goodwill through advertising and research. I submit that provision should be made to permit a writeoff of goodwill over a period of not less than 60 months. AMERICAN LIFE CONVENTION LIFE INSURANCE ASSOCIATION OF AMERICA NEW YORK, N. Y. WASHINGTON, D. C., January 7, 1958. To the Members of the Committee on Ways and Means The American Life Convention and the Life Insurance Association of America are two life insurance company organizations with a combined membership of 267 life insurance companies having in force 96 percent of the legal reserve life insurance business in the United States and Canada. These 2 associations present for your consideration 7 proposals for amendment of the Internal Revenue Code of 1954. The proposals made herein deal primarily with the taxation of owners or beneficiaries of life insurance policies and annuity contracts. If in the course of the hearings before your committee there are statements bearing on life insurance taxation which call for an answer, we should appreciate the opportunity of commenting. AMERICAN LIFE CONVENTION, Executive Vice President and General Counsel. Vice President and General Counsel. AMERICAN LIFE CONVENTION AND LIFE INSURANCE ASSOCIATION OF AMERICA, INTERNAL REVENUE CODE REVISIONS 1. Transfer of life-insurance policies for valuable consideration: section 101 (a) (2) The income-tax exemption granted to death proceeds of life-insurance policies is, under section 101 (a) (2), denied with respect to the proceeds of policies which prior to the death of the insured were transferred for a valuable consideration. Primarily in recognition of the need for life insurance in partnership and small corporation buy and sell agreements, the 1954 Internal Revenue Code specified exceptions to the transfer for value rule, so that now the exemption of death proceeds is not affected by a lifetime transfer for value to the insured, to a partner of the insured, to a partnership in which the insured is a partner or to a corporation in which the insured is a shareholder or officer. In the great mass of detail involved in enacting the code of 1954 Congress overlooked a further category which obviously should be included as consistent with the other main categories. That category is the transfer of an insurance policy to a stockholder of a corporation in which the insured is a stockholder. Life insurance is used in partnerships to fund agreements for the purchase by surviving partners of a deceased partner's interest. Otherwise the partnership assets would have to be divided and the partners' shares distributed. Similarly, with small corporations, life insurance is used to fund the purchase by the corporation in stock-redemption agreements, or by the other stockholders in stock-purchase agreements, of the stocks of a deceased shareholder in order to prevent their sale by the estate to strangers who would have no interest in the welfare of the corporation, or their distribution to heirs who might also not be disposed to consider the good of the business. Loss of management con tinuity through death of key individuals and sale of the interest by the estate to outsiders is recognized as a major threat to small business. Generally, the most convenient arrangement is the purchase of new policies specifically for purposes of the agreement which has been entered into. However, in many cases this is not possible or practicable since the partner or shareholder may no longer be able to obtain new insurance. In this event, the parties may desire to utilize policies which can then be transferred to the partnership, to other partners, to the corporation, or to other shareholders, as the case may be. By its exceptions to the transfer for value rule, the code recognizes all of these except the latter. Provision for cross purchases or exchange of policies among stockholders has become more and more important during recent years because of recent court cases and rulings of the Internal Revenue Service which have placed many stock retirement agreements funded by corporately owned life insurance in doubt. Although the courts are clearing up some of these problems, there are many cases in which a cross-purchase agreement will remain the most desirable form of arranging for acquisitions of the interest of a second shareholder, and this is true particularly where members of a family or beneficiaries of a stockholder's estate are among the surviving shareholders (see Revenue Ruling 56-103). Certain other categories which should be included in the exceptions are transfers between members of a family, particularly where the transfer is incident to marital agreements, and transfers to a trust under corporate buy and sell agreements, to provide for such agreements in cases where local law prevents purchase by a corporation of its own stock. The desirability of stock purchase agreements and the principle of protecting small business are well settled. We urge, therefore, the significance of amending the code to take care of the oversight which occurred in 1954. The following amendment would accomplish this purpose: Section 101 (a): "(2) TRANSFER FOR VALUABLE CONSIDERATION.-In the case of a transfer for a valuable consideration, by assignment or otherwise, of a life insurance contract or any interest therein, the amount excluded from gross income by paragraph (1) shall not exceed an amount equal to the sum of the actual value of such consideration and the premiums and other amounts subsequently paid by the transferee. The preceding sentence shall not apply in the case of such a transfer * "(B) If such transfer is to the insured, to a spouse, former spouse, parent, or lineal descendant, or adopted child of the insured, to a partner of the insured, to a partnership in which the insured is a partner, to a corporation in which the insured is a shareholder or officer, or to a shareholder of a corporation for the purpose of funding, in whole or in part, a buy and sell agreement relating to stock of the corporation in which the transferee and the insured are shareholders, or to a trust established to effectuate such a buy and sell agreement." 2. Attrition of ownership of stock: subchapter C, sections 302 and 318 A corporate distribution in redemption of its stock is considered a purchase of that stock with resulting capital gain or loss to the stockholder if the transaction is a total redemption of the stock of that stockholder or if it substantially reduces the proportion of the stock of the corporation held by the stockholder. Otherwise, the distribution by the corporation is generally treated as the payment of a dividend. If the individual stockholder submits all his stock for redemption, few problems arise. However, if only a part of the stock of the stockholder is surrendered, then after the redemption the stockholder must have less than 50 percent of the stock and his proportionate share of the corporate stock must be less than 80 percent of his share prior to the partial redemption. For this purpose, the stockholder is deemed to own the stock held by members of his family, and if his own holdings and those of his family are not reduced to the required proportions, the distribution is treated as a taxable dividend. The Advisory Committee on Subchapter C has considered this attribution of ownership rule and found that it is too inclusive. Obviously, control over the stock held by another, no matter how closely related, cannot be conclusively presumed, even though it may need to be carefully examined. To this extent, we endorse the report and the recommendations of the advisory committee. An additional problem not adequately covered by the recommendation of that group arises with respect to attribution of ownership to an estate of the stock owned by a beneficiary of the estate. In this case, unlike the case of an individual surrendering stock, even the total redemption of the stock of the estate does not prevent the application of the attribution rules. Thus, in no event can there be a stock redemption for an estate without reference to the beneficiaries. The rule presumes that there is identity of control and of interest and that the possibility of channeling off profits at capital-gain rates presents a temptation to the parties. This rule is not jutsified in the case of stock which is redeemed pursuant to the terms of a buy and sell agreement entered into during the lifetime of the deceased stockholder. Stockholders in small corporations have come to utilize buy and sell agreements as an essential feature in maintaining their businesses. In fact, stock redemption agreements, funded by life insurance, are recommended by the Small Business Administration. In this case, the corporation and estate have no choice but to abide by the agreement entered into, the corporation to buy and the stockholder to sell at an agreed price (which may well not be as great as the fair market value at the time of death). The corporation must buy, ordinarily, without regard to whether or not there are profits, and without regard to the relationships of the other stockholders. In essence, the redemption of stock is primarily a matter between the individual and the corporation, not between the estate and the corporation, since the estate is merely the agency by which the terms of the agreement entered into by the stockholders as individuals are carried out. The estate has no opportunity to initiate action to take advantage of favorable tax consequences. There are many who feel that present law could be interpreted so that the rules applicable to redemption of stock held by individual, rather than by estates, would apply where there is an agreement for the redemption of the stock entered into during the life of the stockholder, so that no stock not owned by the estate would be attributed to it. However, the Internal Revenue Service has held to the contrary in Revenue Ruling 56-103, and corrective legislation is needed. The heavy reliance by the advisory group on administrative interpretation would not be sufficient help. The attribution rules of section 318 of the code were written to guard against subterfuge in the channeling profits of a corporation to majority stockholders. Obviously they should not apply where, by preexisting agreements, the parties have removed any power in themselves to effect such a subterfuge. Thus, although we agree in principle with the advisory group's recommendation on this subject, we feel that it leaves unanswered an important need in an area in which administrative relief is quite doubtful. For this reason, we recommend that the attribution rules of section 318 be made specifically inapplicable to a complete redemption of the stock of a deceased stockholder pursuant to a contract providing for such complete redemption to which the stockholder and the corporation are parties, and that careful consideration be given to the whole subject of attribution of ownership of stock in cases involving buy and sell agreements. 3. Discriminatory taxation of investment income under insured pension plans A serious discrimination exists at present between the Federal income-tax treatment of insured pension plans and that of uninsured pension plans. If an industrial pension plan is funded by annuity, endowment, or life insurance contracts purchased from a life insurance company, the investment income earned each year becomes subject to the approximately 7.8 percent tax on net investment income imposed on life insurance companies, pursuant to the terms of section 801 of the Life Insurance Company Tax Act for 1955 and 1956. If, on the other hand, the pension plan is funded through a trust not utilizing insurance company contracts-in other words, is uninsured-the investment income earned each year by the pension fund is tax exempt, pursuant to the terms of section 501 (a). A considerable number of life insurance companies, but not all, underwrite private pension plans. The amount of funds involved in both insured and uninsured pension plans runs into many billions of dollars. Currently, this tax on net investment income of life insurance companies has the effect of increasing the outlay otherwise required for an insured pension plan by about 5 percent. For example, an employer who contributes $1 million to an insured pension plan is indirectly charged about $50,000 for Federal taxes on the investment income earned by his contribution over the years. This $50,000 tax would not be paid if the pension plan were funded, without guaranties to employees, through the agency of a bank trustee. 1 Based on an average accumulation period for individual pensions of 25 years. The size of the tax burden can also be appreciated by its comparison with other life insurance company expenses of doing a pension business. Group annuity contracts, to use one example, constitute a widely used medium for funding pension plans, and one for which expenses are shown separately in the published statements of life insurance companies. For such contracts, it is estimated that under current law the Federal taxes on investment income from funds arising from pension plans will exceed the total of all expenses (other than taxes) incurred in the servicing of such contracts. This situation is featured in sales literature issued by corporate trust companies who seek pension trust business in competition with life insurance companies. For many employers it has been a compelling argument which has led them to fund their new pension plans through a bank trustee or to change the method of funding their existing insured plans. The many advantages of insured pension plans, as compared with uninsured plans not providing fundamental guarantees to employees and pensioners, may be lost solely as a result of such discriminary tax treatment. The two most important agencies for funding private pension plans are bank trustees and life insurance companies. There is keen competition between them. Both this competition and the employers' freedom of choice are presently affected by this serious tax discrimination. The discrimination against employees covered by contracts written by insurance companies was the subject of corrective legislation offered as a part of the Life Insurance Company Tax Act for 1955, as passed by the House. The bill provided for the ultimate exemption of the income earned on insured pension funds. These provisions were, however, deleted by the Senate Finance Committee, without prejudice to the principle involved, because there was insufficient time for hearings before the committee. We urge that this discrimination be ended. 4. Profit-sharing plans with fixed benefit formula: section 401 (a) As set forth in paragraph (4) of subsection (a) of section 401 of the Internal Revenue Code a stock bonus, pension, or profit-sharing plan meets an important requirement for qualification if the contributions or benefits provided under the plan do not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees. The current position of the Internal Revenue Service is that a pension plan may meet the test of nondiscrimination by considering either (a) the amount of contributions on behalf of the employees or (b) the amount of benefits provided for employees. However, in testing a profit-sharing plan, the Internal Revenue Service takes the position that only the amount of the contributions on behalf of employees may be considered in applying the nondiscrimination test, and not the amount of benefits to be provided as is permitted for a pension plan This, it is possible to establish a qualified pension plan under which the contributions on behalf of the employees covered under the plan are a fixed percentage of compensation. Each employee then receives whatever amount of retirement income can be purchased by the money contributed for him. Pension plans of this type are commonly referred to as money purchase plans. It is also possible to establish a qualified pension plan under which the benefits provided are a fixed amount per year of service or a fixed percentage of compensation. Because of the inherent advantages of the fixed-benefit approach almost all new pension plans are established on this basis and many of the earlier money purchase plans have been converted to a fixed-benefit arrangement. Nevertheless, either type of plan may currently constitute a qualified pension plan. In the case of profit-sharing plans, however, the Internal Revenue Service contends that because the amounts to be contributed are indefinite the benefits provided under the plan cannot be considered definitely determinable and hence, the test of nondiscrimination must be based on the relationship between the contributions made on behalf of the employees covered under the plan and their compensation. This contention seems difficult to justify in the case of a profitsharing plan utilizing a definite contribution formula. Under such plans the contributions and resulting benefits are not subject to arbitrary determination but denied solely on the profits of the employer as must all other employee benefits depend for their ultimate support. Neither a pension nor a profit-sharing plan can be nondiscriminatory in both the contributions and benefits it provides. Limiting the test of discrimination to |