Section 421 of the code provides that restricted stock option treatment will be available only if an individual is an employee at the time he exercises the option, or if the option is exercised by him within 3 months after he ceases to be an employee. Recognizing the unique and continuing relationship of a retired employee to his employer, it is recommended that the statute be amended to provide that employees who have retired because of disability or age be considered to be employees for all purposes of section 421.

XVIII. AFFILIATED GROUPS (EMPLOYEE PENSION AND OTHER PLANS)

(1) Many pension plans cover more than one corporation and within a corporation may cover more than one group of employees having different coverage as required by union contracts or other agreements. Also union contracts may cover the employees of several affiliated companies. Because of longstanding methods of operation employees may be shifted between affiliated corporations because of change in duties or products or business. In many instances it is impossible to determine actuarially the financial liability for pensions on an individual corporation basis. The liability for pensions may be decreased or increased several times for employees individually and by groups by changing laws and union contracts. These problems have been recognized by the Internal Revenue Service at various times. (See PS No. 14, 1944 P-H par. 66,352; special ruling, October 23, 1944, 443 CCH par. 6632; PS No. 51-A, 1945 P-H par. 76,276; special ruling, 1945 P-H par. 76,281; special ruling, March 5, 1947, P-H par. 76,126; Frederick J. Wolfe, 8 T. C. 689 (1947); PS No. 62, 1950 P-H par, 76,285; and 1954 code sec. 404 (a) (3) (B) re profit-sharing plans.) PS 51-A makes an approach to the problem by allowing contributions to be made to a trust covering two or more corporations in relation to eligible payroll of employees covered by the trust but this solves only one small problem. We recommend a revision providing where more than one corporation is covered by a plan or trust, or both, that the plan shall be considered as the plan of one employer for the various limitations contained in section 404 unless by reasonable actuarial methods the various limitations can be applied on a separate corporation basis and that the taxpayer shall be allowed to choose whichever method suits his situation best.

In addition, the consolidated return provisions of chapter 6 should provide that deductions applicable to such plans shall be allowed on a consolidated basis in a manner similar to the treatment of contributions.

(2) In 1954 the Federal Internal Revenue Code was amended (sec. 404 (a) (3) (B)) to permit other members of an affiliated group participating in a profitsharing plan to contribute proportionately the amount an affiliate would have contributed during the tax year had it not been prevented from doing so by the absence of current or accumulated earnings or profits. Each member of the affiliated group making such a contribution on behalf of a loss member is allowed to deduct the contribution in determining its own taxable income for the year. This salutary amendment should be carried a step further to permit a trust indenture establishing a profit-sharing plan for any group of affiliated corporations whether or not technically affiliated within the meaning of section 1504, to provide for the allocation of contributions in a tax year to participants of all members of the group, including those of a loss member which contributed nothing and for which nothing was contributed by the other members of the group. This would accomplish an equitable result for all participants and over a long period should work to the benefit of the employee participants of each member even though in a given year a member, because of the absence of current earnings and accumulated profits, was unable to make any contribution. Of course, a profitsharing plan covering an affiliated or nonaffiliated group would have to state clearly that contributions in each year would be allocated among the participants of all members, including a loss member, and this would have to be made entirely clear in advance to each participant of every member in the group. By accepting the plan every participant would thus be contracting at the outset for the contributions to be allocated among the participants of all members regardless of a loss year or years by any member.

XIX. TAXATION OF INCOME FROM FOREIGN SOURCES

The following amendments to the present code are suggested:

(1) Section 902 (b) should be amended so as to change the requirement of stock ownership from 50 percent to the lesser of 50 percent or the maximum 20675-58-pt. 241

amount permitted in the foreign country. The purpose of this change is to make allowance for the fact that certain countries limit stock ownership by foreign nationals.

(2) In lieu of the present provisions of section 904 limiting the foreign tax credit on a country-by-country basis, taxpayers should be allowed an annual election between the overall and per country limitations on the foreign tax credit. (3) There should be a carryover and carryback of foreign tax credits to the extent they are unusable because of the operation of the limitations of section 904. Under present law there may be a loss of credit, for example, merely because of a difference between the United States and the foreign law as to timing of income and deductions. Section 37 of H. R. 8381, the proposed Technical Amendments Act of 1957, would accomplish the desired result, and we respectfully urge its enactment.

(4) We urge enactment into law of the proposals originally made by the President and recently reiterated by the Vice President to encourage foreign trade by providing substantial measures of relief from taxation of foreign income in the United States, if this country is not the source of that income.

XX. LOSSES, EXPENSES, AND INTEREST WITH RESPECT TO TRANSACTIONS BETWEEN RELATED TAXPAYERS

Section 267 of the 1954 code, subsection (a), disallows losses from sales or exchanges between the persons who are enumerated in subsection (b). These include "a grantor and a fiduciary of any trust" (sec. 267 (b) (4)).

This subsection which was also in the 1939 code, was doubtless intended (as was the entire section) to deny the deduction of artificial losses created between parties which may be deemed to be incapable of dealing at arms length. We believe that, to the extent this restriction might apply to transactions between a corporation and its exempt employees' trust, it is undesirable. In the first place the control over such transactions which is exercised in connection with determining the tax exemption of such trusts would effectively bar improper transactions. Furthermore, there are reasons why such grantors may be able and willing to sell securities to such a trust on a basis favorable to the trust but which might produce a loss to the grantor. It would not appear that any useful purpose is served by prohibiting such sales and the section is effectively a prohibition.

It might be mentioned that it would be likely that the securities (or other assets) involved in such transactions would frequently be such that it would be regarded as desirable to keep them in a family.

The difficulty could be readily overcome by adding to subsection (b) (4) the words "other than a qualified trust referred to in section 401 (a).”

XXI. CHANGES FROM ACCRUAL TO INSTALLMENT METHOD OF ACCOUNTING FOR INSTALLMENT SALES

Section 453 (c) (2) of the 1954 code was intended to provide relief from the double taxation of profit in the year of change from accrued to installment basis for reporting income. The formula, as stated in the Internal Revenue Code at present, while an improvement over the prior code, still results in a duplication of tax serious enough to prohibit changing from the accrual to the installment basis. This is particularly true where net income is small in relation to gross income.

We believe Congress intended to eliminate completely the double taxation of such income, thus making the installment basis available without penalty to all taxpayers engaged in installment selling. The availability of this method is particularly important in view of the present requirement to pay part of the corporate tax on an estimated basis before and the end of the taxable year and the remainder in only two installments after the close of the taxable year. This accelerated tax payment program greatly increases the spread between payment of tax and realization of cash by taxpayers selling on installment but reporting income on the accrual basis.

A problem that may arise in providing relief from such double taxation is the possible complete elimination of tax in the year of change where the gross income from installment sale is substantially greater than net income. We believe that relief may be granted and this situation avoided in the following

manner:

(1) Determine the income from installment sales as under the 1939 code. (2) Determine in the year of change and each subsequent year the gross income from installment sales, that have been previously reported and taxed on the accrual basis.

(3) In the year of change, or in any applicable subsequent year, deduct the amount of gross income indicated under (2) from the entire taxable income, without regard to this deduction, but in an amount not in excess of a stipulated proportion, e. g., 20 percent of the entire taxable income; any unused amounts would likewise be deductible over succeeding taxable years without time limitations until the entire amount of duplicated income has been deducted.

(4) Nothwithstanding the foregoing percentage limitation, the deduction under (3) shall be at least an amount which will reduce the undeducted duplicated income to an amount equal to the unrealized gross income on uncollected installment accounts at the end of the year.

(5) Appropriate provision should be made for carrying forward the deductions provided in (3) or (4) above in cases of tax-free reorganizations. We further suggest that all taxpayers be permitted to elect to take the benefits of this recommendation in the year in which enacted by Congress, and thereafter only with the permission of the Commissioner. This proposal tends to minimize the possibility of tax avoidance by switching to the installment basis on the occasion of changes in tax rates.

XXII. ANNUAL REPORTING-FEDERAL INSURANCE CONTRIBUTIONS ACT

Section 6011 of the 1954 code provides authority for the requirement of the quarterly filing of form 941 under the Federal Insurance Contributions Act. We believe that annual filing of this return would be just as satisfactory a procedure and would eliminate the tremendous amount of detailed reporting that taxpayers are called upon to make, and would save the Internal Revenue Service and the taxpayer money.

We further believe that the detailed schedules that are required to be attached to form 941 should be eliminated and recommend that the W-2 be made to serve the dual purpose of income tax reporting and Federal insurance contributions reporting.

XXIII. CASUALTY INSURANCE ON PROPERTY OF FOREIGN SUBSIDIARIES (INVOLUNTARY CONVERSIONS)

In Revenue Ruling 56-636 it was held that insurance receipts by a parent corporation in respect of assets lost by a subsidiary do not qualify for involuntary conversion treatment. This ruling appears to be quite correct and, in respect of the normal situation, we do not feel that any statutory amendments are indicated.

There is one type of situation for which correction seems needed, the situation of the foreign subsidiary of the United States parent. In certain foreign countries insurance cover may be obtained only from local insurance companies. Frequently, because of local insurance laws and practices, adequate insurance is unobtainable and any insurance at all may be obtained only at excessive premium costs. The laws of some of these countries, moreover, do not contain provisions similar to the involuntary conversion provision in IRC, section 1033. Because of such lack of obtainable insurance coverage and lack of involuntary conversion provisions, and further, because domestic or foreign income taxes payable or insurance proceeds cannot be insured against, substantial risks in the foreign field continued to go uncovered.

It is therefore suggested that IRC, section 1033 be amended so as to extend the involuntary conversion treatment to situations where a domestic parent insures in the United States or elsewhere the assets of its foreign subsidiary. No United States tax would be assessed on insurance proceeds received by the parent if it contributes the proceeds to its foreign subsidiary and the subsidiary replaces the assets destroyed. In such situations there should be, of course, no adjustment to the basis of the subsidiary stock in the hands of the parent. It should be emphasized that this extended treatment should only apply to domestic parent and foreign subsidiary situations.

XXIV. REFUND INTEREST IN MIXED REFUND AND DEFICIENCY CASES

As the result of the taxpayer victories in the Max Factor and Pan American World Airways cases, the Government now assesses agreed-to deficiencies promptly and, in those cases where, even though there is a corresponding overassessment, it cannot be scheduled in the 10-day grace period, issues notice and demand for the gross deficiency plus interest, thereby setting the basis for a continuing interest charge. This is done despite the fact that the overpayment interest will cease to run upon the assessment (not the interest termination date) of the deficiency against which the overpayment is credited. An alternative procedure which it is understood is offered to taxpayers is to sign a conditional waiver, i, e., one that becomes effective only upon allowance of the proposed overassessment. The difficulty here is also that deficiency interest continues, although if the offsetting overassessment is ultimately allowed there will be at least a partial interest offset.

Thus the shoe appears to have shifted somewhat to the other foot, and, whereas, under Max Factor in delayed assessment cases, the Government was forced to pay interest on an amount owing to the taxpayer for a period for which it could not collect interest on a corresponding amount owed by the taxpayer, taxpayers now find themselves owing deficiency interest for a period for which they cannot collect refund interest on a corresponding overassessment.

As a matter of policy the correct result appears to be that produced by the so-called mutual indebtedness rule, which was uniformly applied by the Government prior to Max Factor. Under that rule overpayment interest ceased when deficiency interest ceased in a waiver case, regardless of when the deficiency was assessed. We recommend that the code be amended to return

to that result-accompanied by a separation of principal and interest on both sides of the computation.

Insofar as our recommendation relates to the mutual indebtedness rule, it is contained in section 72 of H. R. 8381, the proposed Technical Amendments Act of 1957, and should be enacted.

EDISON ELECTRIC INSTITUTE

SECTION 165-LOSSES

It is urged that in order to arrive at true corporate net income for any taxable year, section 165 (g) (3) (A) be amended so that all net losses of corporations in investments, when made for the purpose of advancing their main business, and which are incidental thereto, will be allowed in full as an ordinary loss in the year the loss occurs.

If the corporate taxpayer owns less than 95 percent of each class of the capital stock of a corporation, it will not meet the requirements of section 165 (g) (3) (A) for an ordinary loss. The fact that capital losses may be carried forward for a period of 5 years as an offset to net capital gains in those years does not relieve the inequity since utility companies ordinarily do not have substantial capital gains.

Such net losses are usually the result of transactions which are an integral and essential part of the corporation's operations. For example, groups of electric utilities have recently organized separate corporations to develop electric resources for the Atomic Energy Commission. The electric industry is joining chemical companies in research in the development of generating electricity from nuclear energy. Also, investments have been made in corporations engaged in research for developing new products from natural gas and oil.

SECTION 165-LOSSES, AND SECTION 1231-PROPERTY USED IN THE TRADE OR BUSINESS AND INVOLUNTARY CONVERSIONS

Hurricanes, tornadoes, and floods throughout the country point up a continuing weakness in our Federal tax system.

The authority for deduction of losses resulting from fire, storm, theft, or other casualty in the 1954 code is contained in section 165 which allows a deduction of "any loss sustained during the taxable year and not compensated for by insurance or otherwise."

However, section 1231 requires the taxpayer to group these losses in a given year with gains or losses which arise from:

(1) sales or exchanges of property used in the trade or business held over 6 months, and

(2) involuntary conversion of trade or business properties or of capital assets held over 6 months.

If the total of these items including losses from fire, storm, theft, etc., produces a net gain for the taxable year, such gain is taxable under present rates at 25 percent. Where the net result is a loss for the taxable year, such loss is fully deductible against ordinary income, reducing the amount taxable by 52 percent at present rates.

Accordingly, if a corporation sustains a loss from a casualty, for example, a storm loss which normally would be deductible from ordinary income with appropriate tax benefit of 52 percent, it is compelled to apply such loss against any gains from sales or exchanges of property used in trade or business which happen to occur in the same year, thus reducing the tax benefit of the loss to 25 percent. Fire, storm, and other losses are occurrences which by their nature should call for the fullest possible tax relief. Obviously the taxpayer cannot deliberately control the point of time they are incurred so as to obtain the maximum tax benefit. A storm, for example, giving rise to a loss to a calendar-year taxpayer, should afford the same measure of tax relief whether it strikes on December 31 or January 1 and there is no reason why the tax result should be influenced by a wholly unrelated transaction that happens to have been consummated during the same year.

The inequitable result described may be remedied by amendment of section 1231 (a) (2) as follows:

Striking out the words "destruction, in whole or in part, theft, or seizure or" and adding the following:

"(3) only the excess of gains over losses upon the destruction in whole or in part or theft or seizure of property used in the trade or business or capital assets held for more than 6 months shall be considered for the purpose of this subsection, and

"(4) the excess of losses over gains upon the destruction in whole or in part or theft or seizure of property used in trade or business or capital assets held for more than 6 months shall be deductible under section 165."

This amendment would permit deductions for casualty losses to stand alone under section 165 as intended.

SECTION 172-NET OPERATING LOSS DEDUCTION

Under this section taxpayers are permitted a net operating loss carryover to 5 successive taxable years. Section 7701 (a) (23) defines taxable year to include, inter alia, a fractional part of a year. Thus, a taxpayer which has been filing separate returns is required to file a separate return for a fractional part of a year prior to its inclusion in a consolidated return where the taxpayer became a member of the affiliated group in the middle of its taxable year (determined without affiliation). (See Consolidated Regulations, sec. 1.1502-13 (g).) The taxpayer in this situation would be permitted a carryover to only 4 calendar years. This is inequitable when compared with a taxpayer each of whose taxable years contains 12 months. The latter taxpayer would have 5 calendar years to carry over a net operating loss.

Section 172 should make it clear that the term "taxable year" refers to either 5 calendar or 5 fiscal years of 12 months each to which the taxpayer is entitled to carry over its net operating loss.

The committee reports on this section 172 refer to 5-year carryovers and not to carryovers to 5 taxable years.

SECTION 243-DIVIDENDS RECEIVED BY CORPORATIONS

Section 243 of the Internal Revenue Code continues to tax 15 percent of the dividends received by one corporation from another domestic corporation. Historically, payments of intercorporate dividends have been treated for Federal income tax purposes as nontaxable transfers of funds from one corporation to another. Prior to the Revenue Act of 1936, a corporation receiving dividends incurred no tax thereon. Full recognition was given to the principle that a corporate tax had already been paid upon the earnings distributed as dividends.