such ventures are generally carried on in corporate form, the loss which the participants incur will be treated as a capital rather than an ordinary loss, because no one of the corporate participants will own the required percentage of the stock of the development corporation (95 percent under existing law). In order to remedy this situation, we recommend that section 165 (g) (3) be amended so as to require ownership of no more than 25 percent of the stock of the issuing corporation. Investments by a corporation in 25 percent of the stock of another corporation are not usually stock speculations. In other words, the difference between 25 percent ownership and 95 percent ownership is not neces sarily the difference between speculation and investment. The code should rec ognize this fact. Such investments can be of material benefit to the Nation and they should not be discouraged by the income-tax laws.

The reasoning of the above leads to the recommendation that the effect of the Hunter Manufacturing Corporation (21 T. C. 424) case be eliminated. This can be substantially accomplished by reducing the ownership requirement to 25 percent. It can also be done by providing in section 165 (g) that ownership of stock for business reasons auxiliary to that of the taxpayer shall be accorded the treatment provided by section 165 (g) (3) irrespective of time of purchase. This will clarify the meaning of the Hunter case.

VII. ORGANIZATIONAL EXPENSES

Section 248 of the 1954 code permits, for the first time, the amortization of certain organizational expenses.

We believe there are two serious defects in the section as presently drawn. First, it should not be limited to organizational expenses, but should cover reorganization expenses as well. Second, it should also cover stock-issuance expenses whenever incurred. These would include SEC and stock exchange filing fees, State filing fees, Federal, State, and local taxes, engineering and accounting services, legal fees and expenses, investment counsel fees, costs of prospectus preparation, and other items incident to the stock issue. It should be noted that the expenses of bond issues are deductible pro rata over the term of the issue. Failure to permit the cost of issuing stock to be amortized over a reasonable period creates an undesirable discrimination against equity financing.

VIII. INVOLUNTARY LIQUIDATION OF LIFO INVENTORIES

The proper functioning of the LIFO inventory method breaks down when replacement within the taxable year through normal channels of distribution is rendered difficult or impossible by abnormal circumstances over which the taxpayer has no control. In recognition of this fact, both during World War II and the Korean crisis so-called involuntary liquidation relief was granted whereby taxpayers were permitted to use replacement cost in the final determination of their tax liability even though replacement did not take place for several years owing to war-induced shortage of supplies.

These provisions have now expired, but the need for them has not. It is becoming increasingly apparent that a permanent provision is required to take care of comparable situations that are bound to arise from time to time. Involuntary liquidation relief should be available to any taxpayer whose failure to replace is attributable to any circumstances, occurrence, or condition beyond the reasonable control of such taxpayer, including inability to obtain the goods required to replace his inventories on the open market through the normal channels of distribution by reason of the scarcity thereof.

If a definition of involuntary liquidation in terms of abnormal circumstances is regarded as difficult to administer, a provision which would be relatively automatic in its operation could be adopted. The basic principle of LIFO is that replacement cost is the proper measure of cost in the case of a continuing business. This principle could be applied over a longer span than a single year. Thus, it could be provided that in any case in which inventories declined in 1 year and there was an equivalent inventory increase within the next 5 years, for example, the subsequent increase should be deemed a replacement of the goods previously liquidated. In order to restrict the operation of such a provision to relatively unusual cases, it could further be provided that it would operate only if the liquidation related to goods whose values were determined by sections 471 or 1321, or their predecessors in the 1939 code, at least 5 years prior to the year of liquidation or whenever the taxpayer initially went on LIFO, whichever date was later.

Under former provisions, a year in which involuntary liquidation takes place remains open, for tax purposes, until the year of replacement. We recommend that the income of the year of involuntary liquidation should be adjusted by the difference between the inventory cost and the current replacement cost of the liquidated items. The difference between such current cost and the replacement cost as determined in the year of actual replacement could be adjusted in such year. If replacement is not made the interim adjustment should be reversed in the last year in which replacement would have been recognized.

IX. CAPITAL GAINS AND LOSSES

(1) We submit that taxpayers should be allowed deduction for excess of net long-term capital losses over net short-term capital gains in the year incurred, with tax benefit limited to the rate of tax applicable to the excess of net long-term capital gains over net short-term capital losses.

(2) Such net losses, in the case of a corporation, are usually the result of transactions which are an integral and essential part of the corporation's operations. Accordingly, such transactions should not be penalized as though they were some form of undesirable speculation. The excess of net long-term capital losses over net short-term capital gains should be allowed in full and the carryover provisions of section 1212 should be limited, in the case of corporate taxpayers, to the excess of net short-term capital losses over net long-term capital gains. If the recommendation set forth in paragraph (1) is not adopted, a carryback as well as a carry forward of capital losses should be allowed. Every opportunity should be accorded of satisfying the matching requirement of the statute.

(3) It should also be provided that a taxpayer will be permitted to deduct an ordinary net loss for purposes of the alternative tax, i. e., that the tax should be 25 percent of whichever is the smaller of the net long-term capital gain or the taxable net income in such cases. Such a loss is regarded as absorbed by the capital gain for carryover purposes and, unless it can be used to reduce the capital-gain tax, will never be available for tax purposes. Arguably, such a loss should be available to offset income taxable at full rates, but certainly taxpayers ought not to be deprived of all tax benefit.

X. DEPRECIATION

The inadequacy of the present Federal income tax allowances for depreciation is creating a serious problem for taxpayers. Although the 1954 code provisions represent a big advance over the prior law, much remains to be done if industry is to meet the Nation's requirements for new plants, new jobs, and new products. The tax-depreciation law should fully recognize the increasing importance of obsolescence as a factor in determining useful lives and should permit flexibility of method and rate in order to meet the varying conditions of each taxpayer's business. Failure to do this restricts the momentum of technological advances.

The introduction of new methods in the 1954 code has unfortunately tended to introduce more rather than less rigidity. We urge that a taxpayer be permitted to shift methods or rates as his conditions require. Specifically, he should be allowed the automatic right to shift from any of the methods under section 167 (b) (2), (3), or (4) to the straight-line method or to any method under section 167 (a).

XI. ACCOUNTING TREATMENT OF UNEARNED INCOME

Section 452 of the 1954 code (replealed by section 1 (a), Public Law 74, June 15, 1955) pertained to amounts which under prior tax rules were currently includible in gross income even though such amounts were to be earned, or accrued in the generally accepted accounting sense, in future periods. As provided in the Senate Finance Committee report, it was intended that under section 452 there would be no recognition as income of amounts applicable to a future liability to render services, to furnish goods or other property, or to allow the use of property. Such a provision, which results in conforming tax treatment with generally accepted accounting principles and practices, is essential if the method of accounting is to clearly reflect taxable income. On the basis of available information, it does not appear that this provision would affect any substantial amount of revenue. It is recommended that section 452 be restored to the Internal Revenue Code of 1954.

XII. DEDUCTION FOR ALL EXPENSES ATTRIBUTABLE TO INCOME OF THE TAXABLE YEAR

Good accounting practice requires that there be charged against the income of any year all expenses incurred and all estimated future expenses to be incurred which are attributable to such income. This sound principle was recognized and accepted for tax-accounting purposes by the now repealed section 462 of the Internal Revenue Code of 1954. The report of the Committee on Finance with respect to the repeal bill (H. R. 4725, 84th Cong.) completely vindicated the purpose and effect of section 462 by reaffirming that it is essential that the income tax laws be brought in harmony with generally accepted accounting principles. To this end, the committee announced its intention to report out substitute legislation and it is recommended that this be done promptly. In this connection, H. R. 3104 (85th Cong.) has been introduced to effect conformity of tax accounting and generally accepted accounting with respect to such important items as product warranties and guaranties, discounts, commissions, and vacation pay. With minor changes in this bill, and with one major modification in principle, H. R. 3104 would be an acceptable solution to this problem. The major modification referred to would be one which substituted for the transition year adjustment suggested in H. R. 3104 a provision that the nondeductible portion of the required addition to the reserve in the transition year should be allowed as a deduction over some preestablished reasonable period of years. Enactment by the 85th Congress of such a modified version of this bill is strongly urged.

XIII. VACATION PAY

A critical problem faces many taxpayers if legislation is not enacted promptly to correct the confused, but important, matter of accruals of vacation pay. Under rulings which antedated the enactment of the 1954 code, taxpayers have been permitted to deduct vacation payments to be made in the following year despite the absence of a fixed liabality existing at the close of the taxable year. When this method of deducting vacation pay was adopted, there may or may not have been a compressing of 2 years' deduction into 1 year, depending upon the circumstances. In Revenue Ruling 57-325, the Internal Revenue Service has announced that the provisions of these earlier rulings will continue to be effective for taxable years ending before January 1, 1959, but that there will be no further extension of the period to years ending after that date. Under present law, therefore, many taxpayers will not be permitted to deduct any amount for vacation pay in 1959. This situation should be corrected promptly by appropriate legislation revalidating the principles in effect prior to the enactment of section 462.

XIV. STATUTE OF LIMITATIONS

The committee recommends that the statute of limitations should be the same for refunds as for deficiencies, insofar as dating the 3-year period from the date the return was filed (rather than the original due date) is concerned. To avoid the trap sought to be removed by the 1954 Senate amendment, the 3-year period preceding the filing of the claim during which the tax must have been paid in order to be recoverable should be enlarged to include any extensions of time for filing the return. Section 71 of H. R. 8381, the proposed Technical Amendments Act of 1957, accomplishes this result and should be enacted.

Under section 905 (c) the Commissioner can collect-without any time limitation-the excess of any amount claimed as a foreign tax credit over the foreign tax as finally determined. In the converse situation-where the amount as finally paid exceeds the amount claimed-section 6511 (d) (3) (A) imposes a 10-year limit. Though the 10-year period would be adequate in most instances, such is not always the case and it is recommended that the time limit be removed. Whereas the 1939 code provided a separate and specific period of limitations for excise taxes, section 6511 (a) of the 1954 code establishes a uniform period of limitations for all internal-revenue taxes. This change has created a situation whereby in the case of the excise taxes on services and facilities (where the tax is levied on the purchaser and the seller is responsible for collecting and returning the tax to the Government) the period of limitation on claims or adjustments by the collecting agency is automatically restricted to 2 years. We do not believe that this result was intended and suggest that this artificial limitation be eliminated by special recognition of the situation in which a collecting agency is interposed between the taxpayer and the Government.

XV. STAMP TAXES ON ISSUANCE OF CAPITAL STOCK

Sections 4301 and 4302 of the 1954 code continue the tax on the issuance of capital stock previously imposed by section 1802 (a) of the 1939 code. Controversy has recently developed over the circumstances under which the tax ought to apply, however, and we believe some legislative clarification is desirable. The tax has been interpreted by the Internal Revenue Service as applying to mere increases in the stated value of capital stock without issuance of any shares. This view has been overruled in United States v. National Sugar Refining Co. (113 F. Supp. 157 (S. D. N. Y., 1953)); F. & M. Schaefer Brewing Co. v. U. S. (130 F. Supp. 322 (E. D. N. Y., 1955)); Archer-Daniel-Midland Co. v. U. S. (575 CCH Federal Tax Service, par 9574 (C. A. 8, 1957)); and American Steel Foundries v. Sauber (239 F. (2d) 300 (C. A. 7, 1956)). We believe that the rule in these cases, viz, that the tax does not apply to increases in capital stock which are the result of mere book transfers to the capital account unaccompanied by the issuance of any shares, should be written into the code.

As a matter of fact, the 1947 amendment of section 1802 (a) of the 1939 code dealing with recapitalizations (sec. 4302 of the 1954 code) indicates that the true test should be a dual one; actual issuance of shares plus dedication of an amount to capital for the first time. Unfortunately, as the law now stands, the dedication-to-capital branch of the test is limited to recapitalizations. But there is no reason why a reorganization involving more than one corporation should be treated differently from one which takes the form of the recapitalization of the same corporation. A conspicuous example of a transaction which is presently taxed, but which ought not to be, is one involving a mere change in the state of incorporation. We therefore also recommend that the stock issuance tax be made applicable to stock issued pursuant to a plan of reorganization as defined in section 368 only to the extent that an amount is dedicated to capital for the first time by such reorganization.

Section 141 of H. R. 7125, the proposed Excise Tax Technical Changes Act of 1957, amends section 4302 of the code to read in part as follows:

"(a) Limitation.-In the case of a transfer from any surplus account to capital, the tax imposed by section 4301 on the shares or certificates issued pursuant to such transfer shall not exceed a tax computed on whichever of the following amounts is the lower:

"(1) the increase in capital resulting from such transfer, or

“(2) the aggregate of the amounts in all surplus accounts (other than earned surplus), to the extent such aggregate has not previously borne the tax on the issuance of shares and certificates."

It is earnestly hoped that this bill, which has already passed the House, will also pass the Senate.

XVI. EMPLOYEES' PENSION, PROFIT-SHARING, AND STOCK-BONUS PLANS

In general, the provisions of the 1954 code relating to pension, profit-sharing, and stock-bonus plans are the same as those of the 1939 code with certain liberalizing and desirable changes. However, there are certain amendments which should still be made:

(1) Section 404 (a) (5) provides that a contribution by an employer to a nonqualified employees' trust shall be deductible by the employer when paid if the employee's rights are nonforfeitable at the time of such payment. The regulations (sec. 1.404 (a)-12) go further, by stating the reverse, to the effect that, if the employee's rights are forfeitable at the time payment is made to the trust, no deduction is allowable to the employer for such amount for any taxable year.

This treatment seems to us to be unnecessarily harsh. It is recommended that section 404 (a) (5) be modified to provide that the employer's contributions shall be deductible under this section with respect to the year in which the payment is made to the employee.

(2) Section 503 (c) of the code describes certain prohibited transactions which must not be engaged in between a qualified pension or profit-sharing trust and the employer. It is unfortunate that these prohibitions, which were designed for the situation between a section 501 (c) trust and an individual donor, have been applied to a section 401 trust without refinement or necessary change. For example, section 503 (c) (1) prohibits a loan to a donor without receipt of adequate security whereas section 401 trusts have always been free to invest in the stock of creators and donors. The proposed regulations (Federal Register of January 21, 1956) state that "adequate security" means "something in

addition to and supporting a promise to pay" such that "it may be sold, foreclosed upon or otherwise disposed of in default of repayment." This would make the existing investment of many trusts in debenture bonds a prohibited transaction. In the present state of the bond market, forced liquidation of these bonds would result in sizable and unjustified losses on securities which are prime investments. Further, the proposed regulations leave uncertain the issue of whether a purchase on the open market after original borrowing through debentures will be considered a loan.

A proposal for the modification of this provision appears as section 25 in H. R. 8381 (entitled "The Technical Amendments Act of 1957") which was approved by the Committee on Ways and Means of the House of Representatives during the 1st session of the 85th Congress. The proposed modification would provide substantial alleviation of a most unfortunate restriction. We believe, however, that the problem can be more broadly and completely solved by providing merely that transactions with section 401 trusts be, in the words of section 503 (c) (3), on a basis which is not preferential to the donor or creator.

(3) In regulations and various releases issued since 1942 relating to pension and profit-sharing plans under the 1939 code, the Internal Revenue Service has required that coverage be integrated with social security. Although there has never been any statutory basis for this requirement, reasonably liberal application of the integration rules by the Service kept taxpayer resistance at a minimum. In regulations issued under the provisions of the 1954 code dealing with pension and profit-sharing plans, the Service has now construed its integration requirements so narrowly that it is strongly urged that the statute be amended in such manner as to preclude entirely the application of the integra. tion principle as a requirement for qualification.

(4) Under proposed regulations 25.2511-1 (g) (10), relating to the gift tax, it would be required that a gift tax be paid by an employee if he designates a survivor beneficiary under a pension plan so that a smaller pension or annuity is payable to the employee. We believe the gift tax should be correlated with the estate tax and it is to be noted that under section 2039 (c) of the 1954 code, the value of an annuity received by a beneficiary is excludable from the estate tax when paid from an exempt employees' trust to the extent attributable to the employer's contributions.

Section 57 of the proposed Technical Amendments Act of 1957 (cited above) would correlate the gift tax provisions of the code with the estate tax provisions. Under the proposed bill an employee who irrevocably exercises an election under a qualified plan to have certain benefits paid to a beneficiary who survives him is not to be considered as having made a gift of that portion of such survivor benefits which is attributable to his employer's contribution under the plan. Similarly, the failure to make a designation would not constitute a gift. The exclusion would not apply to that part of the value of the survivor's benefits which is attributable to the contributions made by the employee. The proposed legislation is desirable and should be enacted.

XVII. RESTRICTED STOCK OPTIONS

Section 1014 (d) of the 1954 code provides that the general rule, to the effect that the basis of property acquired from a decedent shall be its fair market value at the date of the decedent's death (or optional valuation date), shall not apply to a restricted stock option which has not been exercised by the employee before his death.

This exception gives rise to an anomalous situation. If a restricted stock option is exercised before death, the stock will have a basis in the hands of the estate or beneficiary equal to its fair market value at date of death (or optional valuation date). On the other hand, stock acquired by exercise of a restricted stock option after the employee's death will have as its basis only the option price, despite the fact that the value of the option (difference between fair market value of the stock at date of death and its option price) is included in the gross estate for estate-tax purposes.

H. R. 9035, which was passed by the House on August 16, 1957, and is now before the Senate Finance Committee, provides for the repeal of section 1014 (d) and for inclusion of the applicable amount of option value in the basis of stock acquired by exercise of a restricted stock option after the employee's death. It is urged that enactment of H. R. 9035 be accomplished at an early date.