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sonable uniform rule which can be applied both to previously executed and future lease agreements.

I take this opportunity to thank the chairman and the committee for the privilege of appearing in this matter and to request that careful consideration be given our suggestion that section 110 be replaced by the former longstanding, court-sanctioned Treasury Department practice and policy.

The CHAIRMAN. Thank you very much.

I am reading from a digest of suggestions having to do with this bill, put out by the joint committee staff. It says:

A suggested solution to the problem is to exclude such taxes from the lessor railroad's income and deny the lessee the right to deduct as rental any taxes it pays the lessor railroad. This would be similar to the present treatment of the Excess Profits Tax Act.

Mr. REYNOLDS. That is exactly what 110 is doing now. I would oppose that, sir.

The CHAIRMAN. Thank you very much. (The following letter was subsequently supplied for the record :)


Berlin, Conn., April 23, 1954. Hon. EUGENE D. MILLIKIN,

United States Senate, Washington 25, D. C. DEAR SIR: As you know, I have had an opportunity to make some minor corrections in my oral testimony before the Senate Committee on Finance and have already returned the data to your chief clerk, Mrs. Springer.

In going over this oral testimony I have had an opportunity to digest a little more the question you asked me upon the completion of my testimony, when you referred to a digest of suggestions put out by the joint committee staff, and, as the record indicates, I opposed these suggestions. There is detailed below further information on this particular point which I am submitting to you for your information and for whatever use you may wish to make of it. I know that the committee hearings are closed and it may not be possible to get this into the record, but I am more interested in having you have the benefit of our thinking as far as this particular point is concerned.

Our point, as you know, is that section 110 denies to lessees any deduction for income taxs paid on behalf of the lessor, even though the lessee is bound to irrevocable contract to reimburse the lessor for all such taxes. The economic result under section 110, when applied to our company as a lessee under a 999-year lease, is virtually the same as the so-called pyramiding system. Both section 110 and pyramiding are inequitable and add tremendously to the cost of our lease. The long-established and consistent Treasury Department practice of including in the lessor's taxable income only the lessee's first income-tax reimbursement on the rental and of allowing the lessee to deduct the total taxes paid on behalf of the lessor is satisfactory to our company, and at the hearing before your committee I proposed that section 110 be rewritten to embrace in the code this long-established Treasury practice and policy. In that connection I want to call to your attention several facts relating to the origin of section 110. These facts have been brought to my attention since I testified.

The rule proposed by section 110 i. e., exclusion from the lessor's income of the income tax paid by lessee on account of lessor's receipt of the rental and the disallowance of the tax payment as an expense deduction of the lessee-originated with the railroad industry.

APRIL 23, 1954. It was proposed to the Ways and Means Committee as a rule to be applied solely to railroad leases. The committee apparently adopted the proposal, but, instead of confining it to railroads alone, has applied it generally to all leases executed prior to January 1, 1954. The report of the Committee on Ways and Means (at p. A36) states that section 110 of H. R. 8300 adopts for income-tax purposes a rule applied in the excess-profits tax under section 101 of the Excess Profits Tax Act of 1930 (sec. 433 (a) (1) (K) of the 1939 code).

During my brief appearance before your committee, you referred to the provisions of the Excess Profits Tax Act of 1950 and inquired whether this would not answer the problem. The provisions of the Excess Profits Tax Act of 1950 referred to in the report of the Committee on Ways and Means with respect to H. R. 8300, and also referred to by you, have no application to the problem facing my company under the proposed provisions of section 110 of H. R. 8300. The aforesaid provisions of the Excess Profits Tax Act of 1950 were adopted to cover a situation peculiar to an excess-profits tax with which H. R. 8300 is not concerned.

The reason for the rule in the 1950 act, as explained in the report of the Committee on Finance, United States Senate, Excess Profits Tax, 1950 (at p. 15), was to prevent the imposition of the excess-profits tax on the amount of tax borne by the lessee on behalf of the lessor, which would thereby have increased the amount of the lease expense to the lessee. Relief from the imposition of a tax at excess-profits tax rates was intended and nothing more.

The Excess Profits Tax Act of 1950 provided the disallowance of the tax borne by the lessee as a deduction in computing the lessee's excess-profits net income for purposes of the the excess-profits tax only (sec. 433 (a) (1) (K)); however, the same adjustment was made in the lessee's income for the baseperiod years to determine the lessee's excess-profits credit (sec. 433 (b) (11)). Thus, the resulting increase in the excess-profits credit substantially compensated a lessee for the disallowance of the deduction in the taxable year for purposes of computing the excess-profits tax. This is not true of the normal tax and surtax imposed by H. R. 8300, for there is no reciprocal benefit derived from the denial to the lessee of the deduction of an ordinary and necessary business expense.

Aside from the excess-profits tax origin of the proposed new rule, my information is that most lessees and lessors of railroad properties are parent and subsidiary corporations. It is obvious that where the lessor and lessee are part of the same corporate family the problem of section 110. is of little importance. However, where the corporations are not related, the loss of the deduction of the tax reimbursement expense assumes very serious proportions. A rule of this kind, advocated on account of the peculiar problems of the railroad industry, should not be applied generally.

To the best of my knowledge, there is no precedent in the entire history and development of the income-tax law and business accounting principles which would deny to a taxpayer an annually recurring out-of-pocket payment which is an ordinary and necessary expense of doing business. Yet that would be the result if section 110 of H. R. 8300 is adopted in its present form.

Again, Senator, thank you very much for the courtesies extended to me. I certainly appreciate your cooperation. Very truly yours,

Vice President and Treasurer.

The CHAIRMAN. Mr. Gillet.



Mr. GILLET. My name is James M. Gillet. I am assistant to the president of Victor Chemical Works, Chicago, Ill.

Victor Chemical Works, Mr. Chairman, is a chemical manufacturing firm that has plants in Montana, California, Illinois, Tennessee, Florida, and Pennsylvania. Most of our operations are connected with the production of phosphates, starting with phosphate rock and continuing through to the production of some 150. chemicals that are used in practically every industry in the country.

I appear before you in connection with a request to clarify section 613 of the code. Since the committee has given the opportunity to discuss these clarifications, this seemed the time to do it. The technical staff of the committee is familiar with that matter and they have a copy of the brief which I would like to have permission to file for the record.

The CHAIRMAN. You want to put it in the record or file it?
Mr. GILLET. I will put it in the record.
(The statement referred to follows:)


Chicago, Ill., April 12, 1954. Subject: Internal Revenue Code of 1954, Section 613 (c) (4). The CHAIRMAN, Committee on Finance, United States Senate,

Washington, D. C. DEAR SIR: As miners of phosphate rock and manufacturers of phosphorus, we respectfully ask the inclusion in section 613, subparagraph (c) (4) (E) of the words, "and the sintering and nodulizing of phosphate rock.” The purpose of this amendment would be to show these processes are ordinary treatment processes required to bring phosphate rock to the state of usable raw material for the manufacture of phosphorus.

Phosphate rock mined in the United States differs in the method of mining, the character and purity of the mineral, and the uses to which various fractions and grades of mineral are put. Some rock is high in phosphorus content, and some is low; rock used for some purposes undergoes somewhat different treatment than the rock destined for other uses. Most of the rock of the quality used for the production of elemental phosphorus is in such a physical form that it must be treated by sintering or nodulizing to make it usable as a raw furnace feed for the electric furnace. These processes are considered by the industry to be “ordinary treatment processes" within the meaning of the Internal Revenue Code. This fact is not specifically set forth in the code, however, and it thus becomes a problem for administrative determination, which can lead to confusion and possibly to unequal treatment of various taxpayers.

The taxpayer now has no assurance that his tax return will be accepted as correct by the next Treasury engineer who audits it, nor that he may not some day be served with a deficiency notice because of the reversal of presently accepted interpretations by some new Commissioner of Internal Revenue.

We ask for no new benefit for the phosphate mine operators who nodulize, or sinter, rock for electric furnace feed. We ask only that the law be made specific in this matter in order that the taxpayer and the Treasury Department may have the same understanding of the intent of Congress. A brief, discussing the matter in detail, is attached for your information. Yours very truly,

JAMES M. GILLET, Assistant to the President.


It is respectfully requested that section 613 (c) (4) (E) of the proposed Internal Revenue Code of 1954 be amended as follows: Subsection (4) (E), after the words “burning of magnesite”, add the words "and the sintering and nodulizing of phosphate rock”.

The sole purpose of the amendment is to clarify the meaning of the term “ordinary treatment process” as applied to phosphate rock in determining percentage depletion, so that the miner of phosphate rock may have a definite basis for determining his proper tax.

Phosphate rock is a mineral being mined in the States of Florida, Tennessee, Montana, Idaho, Wyoming, and Utah. It is the source of all phosphorous for foods, animal foods, plant foods, and industrial purposes. It is utilized in three general processes: first, by drying, grinding, and application to the soil as a plant food; second, by treatment with acids and other chemicals (wet processing) for the production of soluble plant foods and industrial chemicals; and third, by smelting in an electric furnace to liberate elemental phosphorous which is in turn converted to agricultural, industrial, and food chemicals. The first two general uses require rock of high phosphorous content and relatively free from impurities. This type of rock is mined and prepared by the ordinary treatment processes including washing, beneficiating, and drying of the rock as taken from the ground.

The electric-furnace process requires phosphate rock which is in either a small

lump form or which has been agglomerated by sintering or equivalent treatment. The supply of rock which is naturally in the form of small lumps is extremely limited, and is sufficient to supply the needs of only a small percentage of the phosphorous-producing industry. Eighty percent or more of the phosphate rock used in electric furnaces is so finely divided that it is not usable as a raw material until it is agglomerated by sintering to convert the fine particles into lumps.

For economical sintering the rock must have a relatively low melting temperature, which requires the presence of impurities, such as silica and alumina in quantities which would be objectionable if the rock were used for wet process treatment or as fertilizer. Such rock which is unsuitable for wet processing is of value only as furnace feed, and then only after sintering or equivalent agglomerating treatment.

In former years there was no mining of this low-grade phosphate rock except that incidental to the mining of high-analysis rock for wet process and fertilizer use, when it was sometimes unavoidably obtained as overburden or as refuse from the principal mining operations. With the advent of the phosphorous furnace processes, however, the material became of value for furnace use. With the dwindling of supplies of high-grade rock, the mining of low-analysis rock is now being carried on intentionally and in increasing amounts. Deposits which were formerly considered worthless are now of economic value. The development of the furnace process using low-grade rock has thus served to conserve the increased supply of high-grade rock. It has added greatly to the income of private landowners and to the revenue of the United States Government in the form of royalties from the mining of phosphate deposits formerly considered worthless, on private and public lands.

The operation of an electric furnace requires a burden sufficiently porous to permit the escape of phosphorous gases and the proper movement of the burden into the melting zone. These low-analysis phosphates, which are naturally in finely divided form, cannot be used in the furnaces until they have been sintered. It is obvious, therefore, that the sintering step applied to phosphate rock for furnace use is an “ordinary treatment process" within the meaning of the Internal Revenue Code.

"Ordinary treatment processes” as applied to phosphate rock are not specifically defined in the present law nor in the proposed revision. Since no formal ruling of the Commissioner of Internal Revenue has issued on the subject and further, since such a ruling, if issued would always be subject to reversal, it is earnestly requested that the code be amended to put an end to the uncertainty and to permit the taxpayer to know he has made a correct calculation of percentage depletion.

Percentage depletion in the case of furnace-grade rock has, in the past, been calculated generally on the assumption that sintering is properly an ordinary treatment process, and taxes have been paid upon this basis; it is believed, therefore, that the amendment requested would not affect the revenue of the Government. It would, however, remove uncertainty as to the intent of Congress and would provide an adequately defined basis for the calculation of percentage depletion.

Mr. GILLET. Section 613 refers to percentage depletion. Subsection C defines the gross income from the properties on which that percentage depletion is figured, and under that section there is a definition of the term, “mining," which says that mining includes "not merely the extraction of ores and minerals from the ground, but also the ordinary-treatment processes normally applied by mineowners and operators in order to obtain the commercially marketable mineral product or products."

It is this matter of ordinary treatment processes that has never been defined for phosphate rock.

Later on in the section, these ordinary treatment processes are specified for certain of the minerals, but they are not in the case of phosphate rock, and that leaves that matter a matter for administrative determination, with the possibility that the present feeling of the Treasury Department may be reversed at any moment, and some future administrator may reverse something that has previously been



done. The taxpayer never knows when his income tax is filed, whether he is filing it on the correct basis or not.

We have discussed this with some of the Treasury people and they think we are right. Others may not think so.

The CHAIRMAN. Have you discussed it with our staff?
Mr. GILLET. We have discussed it with the staff, yes, sir.

The matter that I am referring to principally is the sintering of phosphate rock. Phosphate rock, as you know, is mined in Florida and Î'ennessee, Colorado, Montana, Idaho and a good deal of it is made in the manufacture of elemental phosphorus. In order to use this rock in the production of phosphorus it is necessary that it be in lump form. The powdered, low-grade phosphate rocks, unless they are made into lump form, will not function in the furnace.

Originally most of the phosphorus was produced from high-grade rock which was mined as pebbles or as plate in Tennessee, but since the growth of the phosphate industry the supply of the lump rock is not enough for the industry.

It has been necessary for us to go to the use of low-grade rocks, which, incidentally, have no other use at all, except in the production of phosphorus and to treat those rocks by sintering, in order to make big particles out of little ones.

This is a sample of phosphate rock as it comes out of a mine we have in Montana. That mine was opened up originally for the purpose of getting fertilizer-grade rock. The owners found that they could not sell the rock because it was of such low quality. We were able to buy it and by sintering the product, converting that fine material into this type we find we can use it successfully in the furnace.

The income-tax returns are being filed now on the basis that sintering is an ordinary treatment process. It is not one of those processes which is banned in certain parts of the act, and therefore it would not make any change in the revenue that the Government receives. By specifying, though, that sintering isn't an ordinary treatment process for phosphate rock we believe we can avoid possible difficulties later on with the Treasury Department which would be of benefit to the Treasury as well as to us.

The CHAIRMAN. Is it a common practice to sinter that rock, by other companies?

Mr. GILLET. It is, yes, sir.
The CHAIRMAN. It is a general commercial practice?
Mr. GILLET. Those who make phosphorus, yes, sir.

We would request, then, that subsection E-that is the last item in section 613—be amended by addition of the words "by the sintering and nodulizing of phosphate rock."

Some people say they are sintered and others say nodulized, but it is the same thing.

The CHAIRMAN. What is the sintering process ?

Mr. GILLET. As we apply it, it consists of putting the powdered rock into a kiln, a rotary kiln where it is heated by a gas flame from natural gas, or byproduct gas, or powdered coal. As it passes down through the kiln it warms up and gradually gets sticky. When it reaches the bottom of the kiln it is hot enough for these small particles to stick together. Those are discharged onto a moving grate where they are treated with a blast of air to cool them and they are then

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