There are two principal defects in the provisions:

First, the criteria by which it is to be applied are vague and indefinite and the Treasury appears to be adopting an unduly rigid position.

Second, the sanction of loss of exemption is much too severe.

Section 504 (a) (1) now provides for the loss of exemption by any organization otherwise exempt under section 501 (c) (3) (with certain exceptions) which accumulates out of the income of the taxable year, or any prior taxable year, income which is unreasonable in amount or duration to carry out the purpose or function constituting the basis for the exemption. The statute provides no objective standards or criteria by which the unreasonableness of an accumulation may be judged. Neither the regulations promulgated by the Treasury under the 1939 code nor those proposed under the 1954 code offer any clue as to what the Treasury will regard as an "unreasonable accumulation."

In the first reported case, Freidland Foundation v. United States, the Treasury unsuccessfully attempted to revoke the exemption of an organization which had just commenced its existence and whose accumulation over a 3-year period amounted to the modest sum of $39,000.

Without more adequate guidance from the statute or the regulations, many foundations feel bound to distribute all their income currently, even though this may mean sacrificing worthwhile longrange objectives. Most foundations are unwilling to finance substantial projects out of capital. The result in many cases is a random sprinkling of income among a number of hastily conceived projects.

But for the vague and indefinite accumulation provisions, charitable organizations could put their planning on a sound, foresighted basis. For example, an organization with an annual income of $150,000 might plan the construction of a research laboratory, hospital, or college dormitory or special project at a cost of $600,000. By accumulating its income for 4 years, it would be in a position to accomplish its objective. However, it is not at all clear whether the Service would regard this as a reasonable accumulation.

Similarly, after the laboratory or hospital had been built, if the foundation were to accumulate its income for an additional period in order to build up its capital to an amount sufficiently large to permanently maintain and endow the project, there is uncertainty as to what would be the status of such an accumulation.

In 1950, Secretary Snyder, appearing before this committee, outlined the accumulation problem in these words:

The abuse to which this type of device lends itself is the retention and reinvestment of a major share of the trust income in a manner which will benefit the grantor.

In my opinion, the section should be revised to take careful aim at this particular abuse without interfering with legitimate charitable activities.

To date, the Service has not rejected the idea that complete distribution of current income may be required. The effect on many exempt organizations has been paralyzing. The absence of clear standards has seriously retarded the work of many foundations.

To remedy the situation, I have three proposals to amend section 504, any one of which would substantially eliminate the problem presented:

1. The reasonableness of accumulations should be determined over a 5-year period, rather than by the accumulated net income of each year.

2. The Service should be required to afford the organization an opportunity to correct the situation before imposing a penalty as drastic as loss of exemption.

3. The penalty for violating the section should be a tax on the income unreasonably accumulated during the year, or at most a tax on all the income, rather than the elimination of the exemption.

The CHAIRMAN. We thank you, sir, for coming to the committee and giving us the benefit of your views.

Mr. CHAPMAN. Thank you.

The CHAIRMAN. Are there any questions?

Mr. Sadlak will inquire.

Mr. SADLAK. Mr. Chapman, on the first page of your statement you

state that

As a lawyer, I have personal knowledge of the difficulty of individual and corporate businesses conducting their affairs in the present tax climate.

Among those difficulties, are there such things as the need for incentive to invest venture capital?

Mr. CHAPMAN. I would say so very definitely. I think that that is one of the factors that I might have had in mind when I stated that.

Furthermore, if you do not mind my adding to the thought that you have suggested, I would like to say that as a practicing lawyer, I feel that the multitude of complexities that are now in the tax law seems to be, in large measure, the result of ever-increasing tax rates.

On too many occasions, even with the best advice that can be obtained, the corporation is not at all sure whether it is on sound ground or whether it is not, in planning some particular project or expansion of its activities.

It is only natural, it seems to me, that as we move down the scale on tax rates, the risk becomes that much less in the event of a mistake of some kind to properly construe the law.

Mr. SADLAK. Do you find, Mr. Chapman, that these people seek and feel that they need some help now, and not at some distant future; that they are in need of that encouragement; that capital, in order to expand, needs help now and not at some later time?

Mr. CHAPMAN. In my opinion, that is absolutely correct.

May I merely make this statement, that your committee is loaded now with all kinds of valuable economic advice and information that has come through these hearings, and it might even be that in solemn deliberation you would find it possible that you could not carry out all the aspects of the Sadlak-Herlong legislation, of which I am very heartily in favor.

But as I say, in my opinion, there should be at least an immediate demonstration of an intent, a present demonstration of intent to reduce taxes. I would rather see that sort of thing on the books, even if it has to be limited in some fashion, rather than to go forward with nothing on the books and with nothing more than a faint hope in the

hearts of the taxpayers that some day will come a time when taxes will be reduced.

Mr. SADLAK. Then, if such were put on the books and there were such a provision, then some unforeseen emergency might arise that would cause a postponement, so that there might also be added a postponement provision.

Mr. CHAPMAN. As a matter of fact, I think your bill anticipates that kind of a problem, in giving the authority to stall on reductions if emergencies arise within certain areas.

Mr. SADLAK. Mr. Chapman, I think that is one of the best provisions of the bill, that it provides for such a contingency, so that even though the original effect and purpose of it is a 5-year plan, it can in the final analysis be a 9-year plan with postponement provisions which are written therein.

Mr. CHAPMAN. I may be wrong, and I do not mean to take too much time here, but as far as I know, this is the first tax proposal that looks toward a gradual decrease in tax rates instead of attempting to do it on a 1-year basis. There is a program for the future which eventually will arrive at a point which would seem to me much more reasonable and much more desirable from the point of view of the economy than what we have at the present time.

Mr. SADLAK. That is all, Mr. Chairman.

Thank you.

The CHAIRMAN. Are there any further questions?
Mr. Reed.

Mr. REED. Mr. Chapman, I want to congratulate you, sir, on your paper. I am very glad to see you here.

Mr. CHAPMAN. Thank you, Mr. Congressman.

Mr. REED. When did you come to locate in Washington?

Mr. CHAPMAN. As a matter of fact, I do not. I am located in New York State.

Mr. REED. I thought you were.

Mr. CHAPMAN. We have a New York and a Washington office. I say that on behalf of my Washington associates, and it happens this morning I am working out of the Washington office.

Mr. REED. I see. Thank you very much.

The CHAIRMAN. Mr. Chapman, would you suggest, in connection with a rate reduction such as you have suggested here this morning, along the lines of the Sadlak-Herlong proposal, that we make other adjustments at the same time in the tax law, or would you just reduce the rates as they suggest without making any of the adjustments that we are told should be made in the law to more equitably and fairly distribute the burden of rates?

Mr. CHAPMAN. My answer to that would be that even under the Sadlak-Herlong bill, tax rates are not going to be reduced to a point where we can afford to continue inequities in the law. If they got down to what I think even the late Senator Norris predicted, that the income-tax rate would never go beyond 2 percent-I think we can find that in the Congressional Record-we are never going to get down to that sort of thing. The rates are still going to be high. Consequently, any inequity is going to result in suffering to the taxpayer who is subject to that inequity.

I can think of all kinds of things I would like to advocate this morning in order to increase the equities of the tax law. The Keogh bill, in my opinion, is something that certainly should be injected into the tax law, even if it has to start on a very moderate scale.

The CHAIRMAN. All of the equity adjustments that you mention provide for additional loss in revenue. Would there be any inequities that might exist in the law today that you would have us adjust that would bring in additional revenues to offset the adjustments that we would make in reducing rates?

Mr. CHAPMAN. It is very difficult for me actually to discover points in the tax law where you can substantially increase the revenue without creating additional inequities or else increasing the rates which we want to reduce.

I am talking strictly about the income-tax law.

In my opinion, therefore, if additional revenues are going to be realized, it seems to me that they should be sought in sources other than the personal income and corporate income taxes.

The CHAIRMAN. Am I justified, then, in having the thought, from what you say, that the only inequities and the only unfairness that exists in the Internal Revenue Code are within the rate and the fact that we are taking too much from the taxpayer? Is that the situation? Mr. CHAPMAN. No.

The CHAIRMAN. Or is there at the present time fairness and equity in the distribution of the burdens in the Internal Revenue Code? Mr. CHAPMAN. Are you talking within the confines of the income tax?

The CHAIRMAN. Yes.

Mr. CHAPMAN. I thought I said just a few minutes ago, but might not have made myself clear, that I think there are any number of inequities in the present structure.

The CHAIRMAN. Some of them are in favor of the taxpayer, who enjoys the exception, is that right, or are they all in favor of the Government?

Mr. CHAPMAN. I am talking from the taxpayer's point of view, so that any inequities that run in the taxpayer's favor I would call by a different name, such as, conceivably, loophole.

The CHAIRMAN. I see.

Thank you, sir, very much for coming to the committee and giving us the benefit of your views.

Mr. CHAPMAN. Thank you.

Mr. CURTIS. Mr. Chairman.

The CHAIRMAN. Mr. Curtis of Missouri is recognized.

Mr. CURTIS. Mr. Chairman, I have recently received from an esteemed citizen of St. Louis, Mr. Walter C. Hecker, a statement in support of a bill, H. R. 130, which I introduced. The meritorious purpose of this legislation is to amend the Internal Revenue Code of 1954 so as to allow a longer period of claiming refund or credit of income tax under circumstances of the claim being based upon a judicial decision affecting tax liability in a similar case. Mr. Hecker's able statement deserves the sympathetic attention of the membership of this committee and I will ask that Mr. Hecker's statement be included at this point in the record and that copies of that statement be furnished to the membership of the committee at this time.

The CHAIRMAN. Without objection it is so ordered.

(The statement referred to is as follows:)

STATEMENT OF WALTER C. HECKER, ST. LOUIS, MO.

In the reorganization of the Frisco Railroad during 1947, the holders of Frisco defaulted bonds, which had been purchased flat, received new issues of bonds, preferred stock, common stock and some cash-all of which new issues and the cash, the Commissioner of Internal Revenue ruled were ordinary income.

The holders of the Frisco defaulted bonds in filing their returns in March 1948 for the taxable year 1947, obviously, were governed by the Commissioner's ruling. The statute of limitation for these tax returns was March 15, 1951-yet witness 3 court decisions, 2 of which were made a very short time after the statute of limitation of the taxpayer had expired; namely, only 2 months in 1 case and 7 months in the second.

In the case of William W. Carman v. Commissioner of Internal Revenue, United States Court of Appeals, Second Circuit, No. 173, on May 23, 1951, ruled against the Commissioner and also against the Tax Court, the latter of which had upheld the Commissioner. This case covered Western Pacific Railroad securities, similar in facts to the Frisco Railroad. The Carman case was appealed and the United States Court of Appeals held it was a capital gain and not ordinary income.

Since the Carman case, the Second Circuit of New York, in the Willis Wood case, on October 26, 1951, also held the new issues of bonds, preferred stock, common stock, and cash received in lieu of defaulted Frisco bonds, was capital gains instead of ordinary income.

Now witness in the third case namely, A. J. Dunbar v. Commissioner of Internal Revenue, United States District Court, Eastern Division of the Eastern Judiciary District of Missouri, Case 8896, Division No. 3, on August 4, 1953, also overruled both the Commissioner of Internal Revenue and the Tax Court, holding that the new issues of bonds, preferred stock, common stock and cash, received in lieu of the defaulted Frisco bonds, were capital gain and not ordinary income. Now here is what we have: One decision was as of May 23, 1951, only 2 months after statute of limitation had expired; another decision was as of October 26, 1951, or only 7 months after statute of limitation had expired; third decision was of August 3, 1953, or 2 years 5 months after statute of limitataioin had expired. Note that these three decisions were after the statute of limitation had expired, hence, the taxpayer could not have filed for a refund on or before March 15, 1951, as the Commissioner would have rejected such claims due to the statute of limitation then in effect.

H. R. 130 was introduced by Congressman Thomas B. Curtis to amend the Internal Revenue Code to allow a longer period of time for claiming refund or credit of paid income tax where the claim is based upon a judicial decision affecting tax liability in a similar case.

I am, no doubt, only one of many who has been compelled to pay an unjust income tax because both the Commissioner of Internal Revenue, as well as the Tax Court, having erroneously ruled that the purchasers of Frisco defaulted bonds, when they received the new issues of bonds, preferred stock, common stock and some cash in lieu of their defaulted Frisco bonds, had to consider same as ordinary income instead of capital gain.

Had the holder of the Frisco defaulted bonds filed claims prior to the expiration of the statute of limitation same would have forthwith been rejected because the then Commissioner's finding had already been upheld by the Tax Court, yet both the Commissioner and the Tax Court were later overruled in three different circuit courts. The Commissioner never appealed these decisions and by his silence acquiesced in the decisions of the three circuit courts.

If a taxpayer makes a fraudulent return, the Government can open his tax return regardless of the statute of limitation.

I am not implying that the Commissioner of Internal Revenue or the Tax Court have perpetrated a fraud upon me, but I submit to you why should I pay approximately $18.000 because of an unjust decision made by both Commissioner of Internal Revenue and by the Tax Court?

The problem is to overcome an inequity arising out of the fact that the statute of limitation of 3 years in which to file claim for refund does not take into consideration that our legal machinery grinds slowly and it is sometimes many years from the happening of an event to have a decision from the lower courts, and sometimes as long as 10 years from the Supreme Court, in the event of an appeal.