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his delegate, although the regulations state that such permission is required.

We believe the regulations state the proper rule. We believe there should be some administrative control of such changes, in much the same manner as there is administrative control of changes in taxable years by any other type of taxpayer.

We therefore suggest that the code be amended to make it clear that in such circumstances the principal partner must request permission of the Secretary of the Treasury or his delegate before such a change may be made.

On this score, I should like to digress a moment to talk of the regulations dealing with changes of taxable years. The regulations very properly require that before a taxpayer may change his taxable year, he must set forth a substantial business purpose for the change. Then the regulations go on to state that if the effect of the change would be a reduction in tax liability, by reason of the shifting of income or deductions, that result alone would be enough to defeat the request.

We think there is undue emphasis on the point of a shift of tax liability. We believe that a shift in tax liability is a factor which must be considered in determining whether or not there is a substantial business purpose. But we do not believe a shift of tax liability should be the sole and controlling consideration.

However, we make no specific statutory recommendation on that score, but suggest to the committee, if the committee agrees with our thinking, that a statement along the lines I have been talking about be embodied in the committee report, which we hope will lead the Commissioner to change the emphasis in his regulations.

The last point I should like to discuss is the close of a taxable year upon the death of a partner. This item is shown as No. 7, and appears on page 15 of our revised report.

The purpose of the proposal is to give taxpayers a greater degree of flexibility, in determining whether the taxable year of a deceased partner should close with respect to his partnership income. The present statute may best be set forth by example.

Let us assume a partnership which is on a calendar-year basis, and let us assume a partner, a member of that partnership, also on a calendar-year basis, dies on December 1. He has been a member of this partnership for 11 months. Because of his death, his taxable year closes on December 1.

However, under the present code, the taxable year of the partnership does not close with respect to him or with respect to any other partners. The taxable year of partnership continues to December 31. Because the taxable year of the partnership does not close, none of the income of the partnership is includible by the representatives of the deceased partner in his final return for the 11-month period ended on December 1. That result may be very inequitable.

The partner, for example, may have incurred substantial expenses, deductible expenses, during the last 11-month period of his life, and if his partnership income is not reported in this period he might have no income to offset against these expenses. He may also be entitled to income splitting with respect to partnership income, and that would not be available here. Primarily, however, he may lose the benefit of exemptions which are given to him for the 11-month period.

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In order to remedy the situation, therefore, we propose and suggest to this committee, that the partnership year close with respect to the deceased partner at the time of his death. That means that the deceased partner, or, rather, the representatives of the deceased partner would reflect in his final return, ending on December 1, his share of the income of the partnership from January 1 to December 1. But that provision is not mandatory.

If the successor in interest, or if the representatives of the deceased partner, choose, they may elect to continue the taxable year of the deceased partner to the normal end of the partnership year. In other words, representatives of the partner are given flexibility, they can either decide to close the taxable year as of the date of death or they can decide to continue the taxable year as the present statute requires. Now if at some time the partnership interest is disposed of, then, of course, the option to elect would necessarily terminate and the partner's taxable year would terminate and end as of the date of the disposition, exchange, or other sale of the particular interest. Thank you for your attention.

Mr. FORAND. Are there any questions?

Mr. Keogh?

Mr. KEOGH. With respect to the suggested amendment of 706 (c) on page 16 of your revised report, I note that you have not incorporated that in your suggested rearrangement.

Mr. JANIN. I am sorry, sir, I cannot hear you.

Mr. KEOGH. In connection with the suggested amendment of 706 (c) appearing on page 16 of your revised report, you have not incorporated that in your suggested rearrangement of the provisions.

Mr. JANIN. We have, sir. It appears on page 31 of the suggested rearrangement as section 764.

Mr. KEOGH. I see. You have adopted that since this report?

Mr. JANIN. No, sir. Our revised report deals with only the present sections of the code. It is a separate suggestion of ours. Under the rearrangement, this particular section would appear in section 764. Mr. KEOGH. Thank you.

Mr. FORAND. Are there any other questions?

If there are no further questions, we thank you.

Mr. WILLIS. The next witness will speak on termination of the partnership upon the sale of an interest of 50 percent or more, and also on the limitation of the distributive share of a partnership's net loss. Mr. Herbert Story.

Mr. STORY. Mr. Chairman, and members of the committee, the item I shall discuss is found on page 20 of the revised report of the advisory

group.

First I would like to discuss the present law provisions, some of the problems involved, and then the recommendations of the advisory group.

Normally a partnership is considered terminated if, within a 12consecutive-month period, there is a sale or exchange of 50 percent or more of the total interest in capital and profits of the partnership. This is so whether or not the sales or exchanges are to existing partners or to third parties. The regulations issued under this section, however, have in effect provided relief from this sale or exchange provision in the case of the 2-man partnership, where 1 retires or dies, and he or his heirs receive section 736 payments for a period of time.

The regulations also provide that the liquidation of a partner's interest in a partnership, or the contribution of the property to a partnership that would effectuate such a 50 percent or more change, is not to be considered as a sale or exchange. The regulations issued under section 731, however, provide that where contributions and distributions are made within a short period, they are to be treated as an exchange if, in fact, the distribution and contribution were made in order to effect such exchange of property between two or more of the partners or between the partnership and partner.

The advisory group is raising only a few problems in regard to this section. The code refers to "sale or exchange." However, it is the belief of the advisory group that Congress really meant "sales or exchanges," and that is one of the areas that should be changed. Also, the present difference in treatment between sales of interests among partners and contributions to a partnership by existing partners which result in a 50 percent or more change in partnership interests, or distributions by a partnership that would effect such change, does not appear to be justified.

Therefore, your advisory group is recommending that section 708 (b) (1) (B) be amended to provide that a partnership shall not be terminated by sales or exchanges between partners who have been members of the partnership for at least the 12 months prior to such sales or exchanges. It should be especially noted that we are limiting this sale or exchange to partners who have been members for more than the 12-month period.

We further suggest that the report of your committee accompanying any such change make it clear that in case of distributions and contributions by members of the partnership occurring in a short period of time, that where the members of the partnership have been such for less than 12 months, these transactions should be considered as if they were sale or exchange between one of the partners and a third party.

That is all I have regarding this item.

Mr. FORAND. Mr. Eberharter will inquire.

Mr. EBERHARTER. This is a general question.

In arriving at a decision as to the recommendation that you would make, gentlemen, I would like to know whether or not you arrived at that decision by majority vote?

Mr. WILLIS. Yes, sir; we always arrived at it by a majority vote. Mr. EBERHARTER. In some instances there was some dissent? That is, it is not unanimous?

Mr. WILLIS. It was practically all unanimous. There were very few areas in which we finally did not reach unanimity of opinion. We started out originally with widely divergent thoughts, but wo came together before we reached a final conclusion.

Mr. EBERHARTER. Then we cannot say, as a matter of fact, that this is a unanimous report of an advisory group, can we? We can say the opinion is not unanimous as to every recommendation, but it is a unanimous report. Would you agree with that?

Mr. WILLIS. That is correct. I think that would be acceptable. It is a unanimous report.

Mr. EBERHARTER. It is a unanimous report, with some difference of opinion as to specific recommendations.

Mr. WILLIS. That is correct, sir.

Mr. EBERHARTER. Thank you.

Mr. STORY. I have one other section, Mr. Chairman, section 752, which has to do with the limitation on a partner's distributive share of losses. This is found on page 43 and 44 of the revised report, dated December 31, 1956.

Under the present law provisions, section 704 (d) provides that a partner's distributive share of a partnership loss is to be allowed only to the extent of the partner's adjusted basis for his interest in the partnership. This section further provides that any excess of a loss over the adjusted basis of the partner's interest is to be allowed as a deduction at the end of the partnership year in which such excess is repaid by the partnership.

In determining a partner's adjusted basis for his partnership interest present law provides that any increase in his share of liabilities. to third parties is to increase the basis of his interest. Thus if a partner's share of the partnership loss gave rise to an increase in liabilities owed a third party, there would be an increase in the adjusted basis of his partnership interest which in turn would enable him to deduct the loss.

Present law appears to provide, however, that if the liability is between a partner and the partnership, such liability has no effect on a partner's basis for his interest in such partnership; whereas as I stated before, the liability to third parties does have such effect.

The group discussed several possible solutions with respect to this section. One of these would provide that where a partner is fully obligated to repay his share of hardship losses, he would receive a basis for his interest to the extent of his obligation. Normally, this would make his share of losses automatically deductible in the year incurred.

Another suggestion has been that the deduction of a partnership loss in excess of the basis of the partnership interest be denied in the year incurred only if there appears to be no reasonable prospect of such partner repaying to the partnership his share of partnership capital consumed in the loss.

Another suggestion discussed by the group, would permit a partner up to the time of filing of a partnership return for making an additional capital contribution, in order for him to deduct his share of a partnership loss.

Your advisory group after considering these alternatives decided to make the following recommendations with respect to this section:

We recommend that where a partner is fully obligated to pay a liability to the partnership, that he receive an increase in the basis of his interest to the extent of his obligation. This would accord such liabilities the same status as liabilities to third parties.

Your advisory group does not believe that there should be any distinction between the liability of a partner to the partnership and a share of liability of the partnership to third parties. Furthermore, it is believed that this proposed change would help conform the tax law to generally accepted accounting principles.

As stated before, this will normally make any loss deductible in the year in which incurred by the partner.

In view of our recommendations, we are recommending that subsection (a) of section 752 of the code be amended to provide in the case of the liabilities of the partner that any increase in a partner's

liability to the partnership is to be considered a contribution to the partnership and, thus, increase the basis of his interest. Similarly, with respect to a decrease, it is suggested that subsection (b) of section 752 be amended to provide that any decrease in the partner's liability to the partnership be considered as distribution by the partnership and, thus, decrease the basis of the partner's interest.

That is all I have to say on this section, Mr. Chairman.

Mr. FORAND. Are there any further questions?

Mr. KEOGH. I am trying to follow-obviously, somewhat ineptly— this entire presentation. On page 44 of the report, in the upper center of the page, you say:

To carry out the recommendation of the advisory group, it is recommended that both subsection (a) and (b) of section 752 be amended,

and so forth. Looking at the rearrangement that you have given me, I cannot find section 752. I am wondering how someone reading this revised report, attempting to evaluate whether you have done what you have recommended to do, can locate it in this rearrangement.

Mr. STORY. That can be found, I believe, on page 28 of the suggested rearrangement, and it will become section 746.

Mr. WILLIS. Mr. Keogh, there is also another cross-reference index. If you will turn to the first part of the revised report on page 4, we show the existing numbers and where they will be found in the rearrangement. At the bottom of that, following section 751, you will see, at the bottom in parentheses, sections 752, 753, 754, and so forth, become, respectively, and then they list the new section numbers.

Mr. KEOGH. My attention had not really been called to that. That is from page 2 on; 2 to 6?

Mr. WILLIS. Yes, sir.

Mr. KEOGH. It would seem to me that, in this suggested rearrangement, you ought to set on the existing law as it is, so that those who read it would know what has been taken out, with your cross-references, and they can refer to the new section to see whether you have done adequately what you have recommended be done.

Mr. WILLIAMS. Mr. Keogh, I apologize for the fact that that has not already been done. The simple fact is that when we went to prepare this separate document, which does contain the rearrangement, it turned out to be one of those last-minute operations. As a matter of fact, sir, this was not completed until about 7: 30 or 8 o'clock last night. It was printed overnight. It is just one of those things, and I apologize on behalf of the group, and also on behalf of our secretary, who had undertaken to do it.

Mr. FORAND. Are there any further questions?

Mr. EBERHARTER. Let me ask Mr. Williams this: Do you think you gentlemen could assist the staff in having that done, as suggested by Mr. Keogh?

Mr. WILLIAMS. I think it can be done quite simply. I agree it would be helpful to the committee.

Mr. MASON. And the staff could do it without your assistance. Mr. WILLIAMS. Certainly. It is a mechanical job. I am confident it could be done. I am sure the Revenue and Treasury folks would be glad to help. We would be glad to help, certainly.

Mr. WILLIS. The next witness will speak on the subject of transfer of a capital interest in a partnership as compensation for services. Mr. Laurens Williams.

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