Tax revision issues, 1976 (H.R. 10612)


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Tax revision issues, 1976 (H.R. 10612)
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United States -- Congress. -- Joint Committee on Internal Revenue Taxation
United States -- Congress. -- Senate. -- Committee on Finance
U.S. Govt. Print. Off. ( Washington )
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Table of Contents
    Front Cover
        Page i
        Page ii
    Table of Contents
        Page iii
        Page iv
    1. U.S. taxation of foreign income -- an overview
        Page 1
        Page 2
        Page 3
        Page 4
        Page 5
    2. Tax deferral
        Page 6
        Page 7
        Page 8
    3. Foreign tax credit
        Page 9
        Page 10
        Page 11
        Page 12
        Page 13
        Page 14
    4. Amounts primarily affecting individuals
        Page 15
        Page 16
        Page 17
        Page 18
    5. Money or other property moving in or out of the United States
        Page 19
        Page 20
        Page 21
        Page 22
        Page 23
    6. Special categories of corporate tax treatment
        Page 24
        Page 25
        Page 26
        Page 27
        Page 28
    7. Domestic international sales corporations
        Page 29
        Page 30
        Page 31
        Page 32
Full Text
Vii" /~ I/L/:


(H.R. 10612)







APRIL 14, 1976






Digitized by the Internet Archive
in 2013


Introduction------------------------------------------------------ 1
1. U.S. taxation of foreign income-an overview------------------ 1
2. Tax deferral------------------------------------------------ 6
3. Foreign tax credit---___---------------------------------------- 9
Credit limitations ----------------------------------------- 11
Less developed country corporations------------------------- 12
Treatment of capital gains -------------------------------- 13
4. Amounts primarily affecting individuals------------------------ 15
(A) Exchlusions for income earned abroad------------------ 15
(B) U.S. taxpayers married to nonresident aliens------------_ 16
(C) Treatment of foreign trusts and excise tax on transfers of
property to foreign persons------------------------- 17
5. Money or other property moving in or out of the United States-_ 19
(A) Investments by foreigners in the United States--------- 19
(B) Treatment of reorgainizations involving foreign corpo-
rations------------------------------------------- 20
(C) Contiguous country branches of domestic insurance
companies -------------------------------------- 22
(D) Transition rule for bond, etc., losses of foreign banks --- 23
6. Special categories of corporate tax treLtment------------------- 24
(A) Western Hemisphere trade corporations---------------- 24
(B) Corporations conducting business in possessions--------- 25
(C) China trade act corporations------------------------- 27
7. Domestic international sales corporations --------------------- 29


This pamphlet presents background information on a number of
proposals designed to modify the tax treatment of foreign or export-
related income. The proposals described here are those which were in
the House-passed bill (H.R. 10612). There are, of course, other pro-
posals relating to foreign or export income which could be considered.
Subsequent pamphlets will discuss other proposals as well as alterna-
tives and possible modifications to the proposals pi esented here.
This pamphlet first presents an overview as to the taxation of
foreign income, including a brief discussion of the general prin-
ciples employed in different countries in taxing foreign income. This
is followed by a discussion of tax deferral, possible modifications in the
foreign tax credit, three modifications made by the House bill in the
tax treatment of individuals with income earned abroad, possible mod-
ifications of provisions in present law affecting money or other prop-
erty moving in or out of the United States, possible modifications of
three corporate categories receiving special treatment, and finally a
discussion of Domestic International Sales Corporations (DISC).
In each of these cases the pamphlet describes present law and the
issues which have been presented. The House provisions, to the extent
they bear on the problem discussed, are also described briefly. As indi-
cated above, subsequent pamphlets will discuss alternative proposals
for dealing with these problem.

1. U.S. Taxation of Foreign Income-An Overview
General Princ'iples
There are two generally recognized bases for any country's jurisdic-
tion to tax income: (1) jurisdiction over the recipient of the income,
and (2) jurisdiction over the activity which produces the income (i.e..
the source of the income). Thus, a country may tax the worldwide
income of persons subject to its jurisdiction or it may tax income earned
within its borders, or it may tax under both standards.
Tax jurisdiction over an individual may be obtained, as in the
United States, by the residency or citizinslhip of an individual. Tax
jurisdiction over a corporation is determined by place of residency,
which in the United States is the place of corporate organization.
In addition, most countries' tax laws and regulations contain rules
(called source rules) for determining whi ether, and the extent to which,
income is considered as earned from activities conducted within that
country or within some other country.

Since most sovereign nations apply one or both of the above prin-
ciples in taxing their residents and in taxing income from sources
within their borders, two nations often claim the right to tax the same
income. Most nations have developed principles to accommodate these
competing claims and thus avoid what could be called a double taxa-
tion of income. One principle is that the country of the source of
income has the primary jurisdictional right to tax that income. In this
case the country of residence retains a residual right to tax that income.
Since a double tax on this income would tend to discourage capital and
individuals from crossing borders and thus would inhibit international
commerce, most countries which exercise the residual right to tax their
residents and corporations on a worldwide basis allow a tax credit for
income taxes paid to the source country.
UJS. Treatment
Under present law, the United States imposes its income tax upon
the worldwide income of any corporation organized under the laws of
the United States, whether this income is derived from sources within
or from without the United States.' A tax credit (subject to limits) is
allowed for foreign taxes imposed on foreign source income.
Foreign corporations generally are taxed by the United States only
to the extent they are engaged in business in the United States (and
to some extent on other income derived here). As a result, thle United
States generally does not impose a tax on foreign income of a foreign
corporation even though it is owned or controlled by a U.S. corpora-
tion or group of U.S. corporations (or by U.S. citizens or residents).
Such a corporation is subject to tax, if any, by the foreign country or
countries in which it operates. Generally, the foreign source income
of a foreign corporation only will be subject to U.S. tax when it is
remitted to the corporate or individual shareholders as a dividend. The
tax in this case is imposed on the U.S. shareholder and not the foreign
corporation. The fact that no U.S. tax is imposed in this case until
(and unless) the income is distributed to the U.S. shareholders (usually
corporations) is what is generally referred to as tax deferral.
There are, however, exceptions to the general rules set out above
where income of a controlled foreign corporation is taxed to the U.S.
shareholders, usually a corporate shareholder, before they actually
receive the income in the form of a dividend. The procedures subpartt
F of the code) set forth in present law treat certain income as if it
were remitted as a dividend. Under these provisions income from so-
called tax haven activities conducted by corporations controlled by
U.S. shareholders is deemed to be distributed to the U.S. shareholders
and currently taxed to them.
Under present law, a U.S. taxpayer who pays foreign income taxes
on his income from foreign sources is allowed a foreign tax credit
1 Exceptions to this general rule are provided for corporations which
primarily operate in the possessions and for DISCs. Also, a reduced
rate of tax (34 percent) is provided for Western Hemispliere trade

against his U.S. tax on his foreign source income. The credit is pro-
vided only for amounts paid as income, war profits or excess profits
taxes paid or accrued during the taxable year to a foreign country.
This foreign tax credit system is based on the principle that the coun-
try in which business activity is conducted has the primary right to
tax the income from that activity and the home country of the indi-
vidual or corporation has a residual right to tax that income, but only
so long as double taxation does not result. While some countries, such
as France and the Netherlands, avoid international double taxation
by exempting all income from foreign operations, most of the other
industrial nations-including the United States, Great Britain. Ger-
many, Canada and Japan-use the credit system to avoid double taxa-
tion of income.
The foreign tax credit is allowed not only for taxes paid on income
derived from operations in a specific country, but it is also allowed
with respect to dividends received from foreign corporations operating
in foreign countries and paving foreign taxes. This latter credit. called
the deemed-paid credit, is provided for dividends paid by foreio'n
corporations to U.S. corporations which own at least 10 percent of the
voting stock of the foreign corporation. Dividends to these U.S. cor-
porations are considered as carrying with them a proportionate amount
of the foreign taxes paid by the foreign corporation. The computation
of the amount of the foreign taxes allowed as a deemed-paid credit in
the case of a dividend distribution differs depending upon whether or
not the payor of the dividend is a less developed country corporation.
In order to prevent a taxpayer from using foreign tax credits to
reduce U.S. tax liability on income from sources within the United
States, two alternative limitations on the amount of foreign tax
credits which can be claimed are provided by present law. Under
the overall limitation, a taxpayer aggregates his income and taxes
from all foreign countries. A taxpayer may credit taxes from any
foreign country as long as the total amount of foreign taxes applied
as credits in each year does not exceed the amount of tax which the
United States would impose on the taxpayer's income from all sources
outside of the United States.
The alternative to the overall limitation is the per-country limita-
tion. Under this limitation, the same calculation made under the over-
all limitation is made on a country-by-country basis. A taxpayer's
credits from any country are limited to the U.S. tax on tlie amount of
income from that country. Taxpayers are required to use the per-
country limitation unless they elect the overall limitation. Once the
overall limitation is elected, it cannot be revoked except with tlhe con-
sent of the Secretary or his dele-ate.
In cases where the applicable limitation on foreign tax credits re-
duices the number of tax credits which 'aii be used by the taxpayer to
offset the U.S. tax liability in any one year, present law provides that
the excess credits not llsed may be carried back for two years or car-
ried forward for five yea rs.

The significance of the present overseas operation of U.S. firms is
indicated by the fact that the sales (other than petroleum products)
of U.S. multinational foreign affiliates were $254 billion in 1974. The
U.S. share of the book value of U.S. overseas affiliates in 1974 stood
at $118.6 billion-an increase of $15 billion over 1973-of which one-
half represented net capital outlays from the United States and the
other one-half represented reinvested earnings of these affiliates. Data
on U.S. direct investment since 1966 are shown in table 1.

[In millions of dollars]

Book Net Balance-of-
value at capital Reinvested payments
year end outflows earnings I Earnings income2

All areas:
1966 --------------------------- 51,792 3,625 1,791 5,231 3,467
1967-------------------------- 56, 583 3,073 1,757 5,522 3,847
1968...------------------.-------- 61,955 2,880 2,440 6 486 4,152
1969 --------------------------- 68,201 3,190 2,830 7,485 4,819
1970....................... ....-------------------------- 75,456 4,281 3,176 8,023 4, 992
1971.............................-------------------------- 83,033 4,738 3,176 9,002 5,983
1972..... -------------.. ------------- 90,467 3,530 4,532 10,800 6,416
1973 ------------------------- 103,675 4, 968 8,158 16,940 8,841
19743....--------.. --........--------------...... 118,613 7,455 7,508 25,141 17,678
1966--------------------------- 13,893 787 156 1,482 1,339
1967 ---------. ----------------- 15,189 1,102 206 1,751 1, 559
1968--------------------------......... 16,622 1,174 248 1,963 1,735
1969--...------------------------ 17,720 924 29 1,996 1,997
1970-------------------------- 19,730 1,492 575 2,405 1,881
1971 --------------------------.......................... 22,067 1,940 421 2,835 2,457
1972............................. -------------------------- 23,974 1,613 356 3,063 2,739
1973 --------------------------- 27,313 1, 442 1,925 6,128 4,249
1974 -------------------------........................... 30,248 1,158 1,814 13,513 11,699
1966------------------------ 20,740 1,611 918 1,909 950
1967.--------------------------....................... 22,803 1,224 845 1,860 1,018
1968 --------------------------........... .......... 25,160 946 1,357 2,395 1,055
1969. -------------------------- 28,332 1,210 1,987 3,071 1,126
1970............................. -------------------------- 31,049 1,263 1,528 3,141 1,605
1971-----------..--..-------------............ 34,359 1,564 1,796 3,517 1,696
1972......-------------------------- 28,325 1,163 2,830 4,761 1,910
1973............................. -------------------------- 44,370 1,863 4,107 6,674 2,472
19743 ........................... -------50,915 2,712 3,786 6,498 2,636
1966 -------------------------............................. 17,160 1,227 717 1,840 1,177
1967 -------------------------- 18,591 746 707 1,912 1,270
1968 --------------------------- 20,174 760 836 2,128 1,362
1969...........................-------------------------- 22,149 1,056 814 2,418 1,696
1970 --------------------------...... 24,677 1,527 1,073 2,477 1,507
1971..... ------------------------ 26,007 1,234 959 2,649 1,830
1972 --------------------------- 28,168 754 1,346 2,976 1,767
1973.------..---...-----------------...... 31,992 1,663 2,126 4,137 2,120
1974--------------------------............................ 37,450 3,585 1,907 5,129 3,343

I Represents a U.S. reporter's share in the reinvested earnings
I Includes interest, dividends, and branch earnings.
a Preliminary.

of its foreign-incorporated affiliates.

Source: U.S. Department of Commerce, "Survey of Current Business" October 1975.

The earnings, after foreign income taxes, of these foreign invest-
ments were $25.1 billion. $11.1 billion of which represented earnings of
U.S. branches. Of the $14.0 billion of earnings of foreign affiliates, $6.5
billion or 46.7 percent was distributed as dividends to the U.S. share-
holders. The net amount received by shareholders, after foreign with-


holding taxes, was $5.85 billion. An additional $3.S billion was re-
ceived as interest, fees, and royalties. The composition of foreign
source earnings is shown in table 2.
[In millions of dollars]

1974 amount and source

1. Earnings of incorporated affiliates-.------ ---------------------------- 14,049 reported.
2. Earnings of unincorporated affiliates---------------------------- ------11,091 reported.
3. Earnings.--....--- ..-.---. ------------------------------------------- 25,141 equals 1 plus 2.
4. Gross dividends (on common and preferred stock) -----------------6,541 equals 5 plus 6.
5. Foreign withholding tax on dividends---------------------------------- 691 derived.
6. Dividends-..-------------------------------------------------------- 5,850 reported.
7. Interest------- ---------------------------------------------------- 737 reported.
8. Reinvested earnings------------------------------------------------- 7,508 equals 1 minus 4 or 10 minus 9.
9. Balance-of-payments income------------------------------------------ 17,678 equals 2 plus 6 plus 7 or 10
minus 8.
10. Adjusted earnings-.......---- ------------------------------------.. 25,186 equals 3 minus 5 plus 7 or 8
plus 9.
11. Fees and royalties----........-- -------------. --------------------- 3,023 reported.
12. Balance of payments receipts------------------------------------ 20,701 equals 9 plus 11.
13. Direct investors' ownership benefits------------------------------------ 28,209 equals 10 plus 11.
Source: Based on data in "Survey of Current Business", October 1975, pp. 48 and 49.

From the point of view of the U.S. investors, the return on this in-
vestment in 1974 was $28.2 billion (including interest, royalties, and
fees), an increase of $7.8 billion over 1973. This represents a rate of
return of 27.2 percent on the book value of the investment as of the
beginning of 1974.
Of the $28.2 billion of earnings in 1974. $20.7 billion represents a
balance-of-payments inflow (receipts of income on U.S. direct invest-
ment), while $7.5 billion is reinvested earnings. This $20.7 billion
inflow represents a rate of return of 19.9 percent on the book value of
investment at the end of 1973. Of the $20.7 billion inflow. $11.1 billion
is earnings of U.S. branches, dividends account for $5.85 billion, royal-
ties and fees account for $3.0 billion, and intere.-t accounts for $0.7
Earninirs and dividend payouts by type of business activity and
area of the world are shown in table 3. As would be expected, this
shows that a relatively high proportion of dividends are paid out of
earnings from high-tax foreign countries. For example, the petir'oldem
industry pays 75 percent of its earnings from developing countries in
dividends. Manufacturing companies in Europe pay out 50 percent
of their earnings. This table also shows that the worldwide dividend
p!i out ratio of 46.6 percent is increased substantially by the petroleum
industry's practice of repatriating most of its hlighl-tax extraction
income. For example, the worldwide dividend payout ratio of manu-
facturing industries alone is ."0.8 percent.
It is estimated that for 1076 corporate pre-tqix foreign earnings will
be approximately $.25 billion (other than the ext 'active indu-tr'ies).
foreign taxes on this income will be about $10 billion (40 percent of
earnings) and U.S. taxes will be about .2 billion (8 percent of

;9 -r-0(7-76---2

[In millions of dollars, or ratio]

1973 1974 Payout ratio (gross
Gross Gross
Area and Industry Earnings dividends Earnings dividends 1973 1974

All areas------------------- 13,020 4,852 14,049 6,541 0.373 0.455
Petroleum ----- -- -------- 3,260 1,335 4, 088 2,274 .410 .556
Manufacturing -------------------- 6,584 2,477 6, 279 2,493 .376 .397
Other.--------------------------- 3,175 1,049 3,682 1,774 .330 .482
Developed countries ----------- 9,376 3,199 9,630 4,106 .341 .426
Petroleum....... ----------------------- 1,596 356 1,977 796 .223 .403
Manufacturing-------------------- 5,638 2,150 5,278 2,195 .381 .415
Other --------------------------- 2,142 692 2,375 1,114 .323 .469

Canada--- ---------
Petroleum -------
Manufacutring .-------..----..---.-
Other ------------
P E uropeum ........................
Manufacturing- ------- ----
Other-- -------
Other developed-------
Petroleum ----------------------
Manufacturing.- ------
Other --------------------
Developing countries__-...
Petroleum....---- -- --
Manufacturing -----------------
Latin America ------------
Petroleum ---------------------
Manufacturing.. . . . . ..
Other ---------------------
Other developing-------------

2,567 700 3,071 869 .273 .233

596 144 675 162 .242 .240
1,441 432 1,774 484 .300 .273
531 125 623 223 .235 .358
5,544 2,038 5,441 2,719 .358 .500
750 176 1,078 561 .235 .520
3,464 1,393 2,887 1,439 .402 .498
1,331 470 1,476 719 .353 .487
1,265 461 1,118 518 .364 .453
250 38 224 74 .152 .330
734 325 618 273 .443 .442
280 98 276 171 .350 .620
3,014 1,446 3,613 2,055 .480 .569
1,334 840 1,701 1,278 .630 .751
945 327 1,001 297 .346 .297
735 280 912 482 .381 .529
1,519 527 1,597 683 .347 .428
221 65 161 76 .294 .472
730 254 767 232 .348 .303
567 207 659 374 .365 .659

1,495 918 2,016 1,373 .614 .681

Petroleum..... ----------------------- 1,112 773 1,539 1,201 .695 .780
Manufacturing------------ --------- 215 72 234 64 .335 .274
Other-......---------------------------.............. 167 73 243 108 .437 .444
International and unallocated ----- 630 217 805 379 .344 .470

Note: Details may not add to totals because of rounding.
Source: U.S. Department of Commerce, "Survey of Current Business", October, 1975.

2. Deferral
Preseg t Law
Generally, the foreign source income of a foreign corporation is
subject to U.S. income taxes only when it is actually remitted to the
U.S. corporate or individual shareholders as a dividend. The tax in this
case is imposed on the U.S. shareholder and not the foreign corpora-
tion. The fact that no U.S. tax is imposed until and unless the income

is distributed to the U.S. shareholders (usually corporations) is what
is generally referred to as tax deferral.2
Present law, however, provides for an exception to the general rule
of deferral under the so-called subpart F provisions of the Code. Under
these provisions income from so-called tax haven activities conducted
by corporations controlled by U.S. shareholders is deemed to b dis-
tributed to the U.S. shareholders and currently taxed to them whether
or not they actually receive the income in the form of a dividend. The
statute refers to these types of income as "foreign base company
Prior to the Tax Reduction Act of 1975 the three categories of income
subject to current taxation as tax haven income were foreign personal
holding company income; sales income from property purchased from,
or sold to, a related person if the property is manufactured and sold for
use. consumption, or disposition outside the country of the corpora-
tion's incorporation; and service income from services also performed
outside the country of the corporation's incorporation for or on behalf
of any related persons. That Act added a fourth category of tax haven
income called foreign-base company shipping income. Under the Act,
the deferral of U.S. tax for shipping income received by a foreign sub-
sidiary of a U.S. corporation is continued only to the extent that the
profits of the shipping company are reinvested in shipping operations.
In addition, present law provides for the current taxation of the in-
come derived by a controlled foreign corporation from the insurance of
U.S. risks. Foreign base company income and income from the insur-
ance of U.S. risks are collectively referred to as subpart F income.
Present law also provides, with certain exceptions, that earnings
of controlled foreign corporations are to be taxed currently to U.S.
shareholders if they are invested in U.S. property. In general terms,
U.S. property is defined as all tangible and intangible property local ed
in the United States.
Prior to the enactment of the Tax Reduction Act of 1975 there were
a number of significant exceptions to the rules providing for current
taxation of tax haven income. By repealing these exceptions, the Tax
Reduction Act of 1975 substantially expanded the extent to which for-
eign subsidiaries of U.S. corporations are subject to current U.S.
taxation on tax haven types of income. The Act repealed the minimum
distribution exception which permitted deferral of U.S. taxation on
tax haven types of income in cases where the foreign corporations
distributed a minimum level of dividends to their U.S. shareholders.
2 Where it is not anticipated that the income will be brought 1,ick to
the United States. for financial accouniting purposes (in accountin.g for
the income of a consolidated grouin consisting of one or more d,)1'-tic
corporations and its foreign subsidiaries) this income is often shown as
income exempt from 17.S. tax.

This provision was the main device used by multinational corpora-
tions for avoiding taxation of their tax haven income, and its repeal
(together with other changes referred to below) will result in the
current taxation of virtually all tax haven income of foreign sub-
sidiaries of U.S. corporations.
The Act also repealed the exception in present law which permitted
deferral of taxation in cases where the tax haven income was rein-
vested in less developed countries. Finally, the Act modified the pro-
vision which permitted corporations having less than 30 percent of
their gross income in the form of tax haven income to avoid current
taxation. The Act provided that this tax haven income is to be taxed
currently in any case where it equals or exceeds 10 percent of gross
Iss wrs
The merits of the present system of deferral have been frequently
debated in recent years. In 1962 the Administration proposed an
almost total elimination of deferral. Congress responded by focusing
on the abuses of tax haven activities and eliminating deferral for
the types of income which are normally susceptible to tax haven
However, the general debate over whether to eliminate deferral com-
pletely or to limit its use for all taxpayers has continued. No one d(lis-
putes the fact that deferral permits foreign corporations controlled by
U.S. persons to avoid or postpone paying somine U.S. tax by retaining
their earnings abroad. But whether this is appropriate in view of their
separate organization or whether deferral constitutes a significant
incentive for foreign investment and, if so, whether that incentive
means more or less investment (and jobs) in the United States are still
subjects of debate.
House Bill
The Ways and Means Committee decided at this time not to adopt
any basic changes in the deferral provisions of present law. Instead,
the committee referred the subject to a task force for further study.
However, a number of more technical provisions relating to deferral
and the taxation of foreign subsidiaries of U.S. corporations were
included in the bill as it passed the House. Tlhey are set out below.
The definition of investments in U.S. property by controlled foreign
corporations (which are treated as dividends) would he limited by tlie
IToii-:e bill to investments in stock or obligations of a related U.S.
person (not including a subsidiary) and to tangible property leased to,
or used by, such related U.S. person. However, sales between a con-

3 While the above-described provisions in the 19.75 Act. all resulted
in the elimination or tightening of exceptions to the current taxation
of tax haven income, one modification was made in the 1075 Act which
resulted in a relaxation of those rules. This amendment provided
that base company sales income (i.e., income from selling activities"
in a tax haven) does not include income from the sale of agricultural
commodities which are not grown in the United States in commercially
marketable quantities.

trolled foreign corporation and a related U.S. person which are dis-
g Iised dividends would be considered as investments in U.S. property.
The new rules would be prospective except that they would apply as of
19t9 with respect to foreign corporations owning U.S. subsidiaries
which invest, in property situated on the U.S. Outer Continental Shelf.
(Sec. 1021)
Tlhe House bill eliminates the provision in present law which excepts
U.S. shareholders of less-developed country corporations from ordi-
nary income tax on gain from the sale of stock of those corporations (to
the extent of their accumulated profits). This provision would apply to
sales after December 31. 1975, with respect to yearnings accumulated
after that date. (Sec. 1022)
An exception to the definition of foreign personal holding company
income is added by the House bill for income on earned surplus which
must be retained by a foreign casualty insurance subsidiary in order
to satisfy State insurance solvency requirements as to earned pre-
miums. This exception would apply to taxable years beginning after
December 31, 1975. (Sec. 1023)
The tax haven (or subpart F) provisions are modified by the House
bill to exclude from the definition of foreign base company income
shipping between two or more points within the country of incorpora-
tion and registration of the ships. Also, amounts paid on unsecured
loans by companies substantially all of whose assets consist of qualified
investments in foreign base shipping operations would be treated as a
reinvestment in shipping assets for purposes of subpart F. This pro-
vision would apply to taxable years beginning after December 31.1975.
(See. 1024)
The definition of foreign base company sales income is amended by
the House bill to exclude agricultural commodities which are sigonifi-
cantly different in grade or type from. and which the Secretary of the
Treasury determines after consultation with the Secretary of AgrQicul-
ture are not readily substitutable for (taking into account consumer
preferences) agricultural products grown in the United States in
commercially marketable quantities. This provision would apply goen-
erally to taxable years beginning after December 31, 1975. (See. 1025)

3. Foreign Tax Credit
Pr(..e)ft Law
As discussed above (in the Overview section), present law permits
taxpayers subject to U.S. tax on foreign income to take a foreign tax
credit for the amount of foreign taxes paid on income from sources
outside of the United States. The credit is provided only for amounts
paid as income, war profits or excess profits taxes to any foreign
country or to a possession the Unifed States.
The foreign tax credit is allowed not only for taxes paid on income
derived from operations in a foreign country, l)but it is also allowed for
dividends received from foreign corporations operating in foreigir
countries and paying foreign taxes. This latter credit, called the
d(leemned-paid credit, is provided for dividends paid by foreign corpora-
tions to U.S. corporations which own at least 10 percent of the voting
stock of the foreign corporation. Dividends to tbei-e U.S. corporations

are considered as carrying with then a proportionate amount of the
foreign taxes paid by the foreign corporation.4
The computation of the amount of the foreign taxes allowed as a
deemed-paid credit in the case of a dividend distribution differs de-
pending upon whether or not the payor of the dividend is a less
developed country corporation. For less developed country corpora-
tions the foreign taxes paid are allocated between the dividend dis-
tribution and the portion of the earnings used to pay the foreign
taxes. However, this omits from the U.S. tax base the portion of the
earnings used to pay the foreign tax. As a result, where the foreign
tax is less than the U.S. tax (but above zero), this gives an advantage
to dividend income over income subject to the full United States tax.
For developed country corporations the earnings used to pay the for-
eign tax allowed as a credit are included in the distribution base and
the credit for foreign taxes paid is based upon all the earnings, in-
cluding the amount paid as foreign taxes, and not merely the portion
paid as a dividend.
To prevent a taxpayer from using foreign tax credits to reduce
U.S. tax liability on income from sources within the United States,
two alternative limitations on the amount of foreign tax credits
which can be claimed are provided by present law. Under the overall
limitation, the amount of foreign tax credits which a taxpayer can
apply against his U.S. tax liability on his worldwide income is limited
to the ratio of his taxable income from sources outside the United
States (after taking all relevant deductions) to his worldwide taxable
income. Under this limitation, a taxpayer may credit taxes from any
foreign country as long as the total amount of foreign taxes applied
as a credit in each year does not exceed the amount of tax which the
United States would impose on the taxpayer's income from all sources
without the United States.
The alternative to the overall limitation is the per-country limita-
tion. Under this limitation the same calculation made under the over-
all limitation is made on a country-by-country basis. The allowable
credits from any single foreign country cannot exceed the ratio of
taxable income from that country to worldwide taxable income. Tax-
payers are required to use the per country limitation unless they elect
the overall limitation. Once the overall limitation is elected, it cannot
be revoked except with the consent of the Secretary or his delegate.
4 Tlipe rules for the deemed-paid credit apply to distributions to a
domestic corporation from a first-tier foreign corporation in which the
domestic corporation is a 10-percent shareholder and to distributions
from a second-tier or third-tier foreign corporation (through a first-
tier foreign corporation), as long as each receiving corporation in the
chliain of dividend distributions is a 10-percent shareholder in the cor-
poration making the distribution. However, distributions originating
from a foreign corporation that is more than three tiers beyond the
domestic corporate shareholder do not carry with it any deemed-paid
foreign tax credit.

In computing taxable income from any pa-iticular country or from
all foreign countries for purposes of the tax credit limitations, all
types of income are included as well as the deductions which relate
to that income and a proportionate part of the deductions unrelated to
any specific item of income. Thus. for example., income from capital
gains is included in the computation of the credit as well as the deduc-
tions allocable to those gains (e.g., the 50-percent exclusion of capital
gains for individuals).5
In cases where the applicable limitation on foreign tax credits re-
duces the amount of tax credits which can be used by the taxpayer
to offset U.S. tax liability in any one year, precient law provides that
the excess credits not used may be carried back for two years or carried
forward for five years. However, if a person using the per-country
limitation in any year elects subsequently to use the overall limitation,
no carryovers arie permitted from years in which the per-country
limitation was used to years in which the overall limitation was
The Tax Reduction Act of 1975 prohibits the limitation on the
foreign tax credit on income from oil and oil-related activities from
being calculated under the per-country method. Instead. this income
(and any losses) are computed under a separate overall limitation
which applies only to oil-related income. Any losses from oil-related
activities are to be "recaptured" in future years through a reduction in
the amount of allowable foreign tax credits which can be used to offset
subsequent, foreign oil-related income.
In addition, the Tax Reduction Act of 1975 requires that the amount
of any taxes paid to foreign governments which will be allowed as tax
credits on foreign oil extraction income is limited to 52.8 percent of
that income (after deductions) in 1975, 50.4 percent in 1976 and 50
percent in subsequent years.
(a) Credit limitations.-It has been noted that the two alternative
limitations on foreign tax credits present different advantages for
different taxpayers. Some contend that the use of the per-country
limitation permits a U.S. taxpayer wlho has losses in a foreign country
to obtain wliat is in effect a double tax benefit. They point out that since
the limitation is computed separately for each foreign country, branch
losses in any foreign country do not have the effect of reducing the
amount of credits allowed for foreign taxes paid in other foreign coun-
tries on other income. Instead, they note that these losses reduce U.S.
taxes on U.S. source income by decreasing the worldwide taxable in-
come on which the U.S. tax is based. In addition, they note when the
business operations in the loss country become profitable in a sulbse-

5 However, an exception is provided for interest income if that in-
come is not. derived from the conduct of a banking or financing busi-
ness. or is not otherwise directly related to the active conduct of a trade
or business in the foreign country. Such interest income and the taxes
paid on it are subject to a separate per-country limitation to be calcu-
lated without regard to the other foreign income of the taxpayer.

quent tax year, a credit will be allowed for the taxes paid in that
country. Thus, they contend that if the foreign country in which the
loss occurs does not have a net operating loss carryforward provision
('or some similar method of using prior losses to reduce subsequent tax-
able income), the taxpayer receives a second tax benefit when income
is derived from that foreign country because no U.S. tax is imposed on
the income from that country (to the extent of foreign taxes paid on
that income) even though earlier losses from that country have reduced
U.S. tax liability on U.S. source income. Hard mineral companies,
which generally incur substantial losses from new mines, are currently
the primary beneficiaries of the per-country computation.
The overall limitation does not allow this same advantage to be
gained from foreign losses, because these losses are offset against in-
come from other foreign countries rather than against U.S. income.
However, in spite of the fact that in most cases foreign losses do not
reduce U.S. tax liability under the overall limitation, most companies
that operate in more than one country elect to use this limitation be-
cause it is substantially less complex and does offer other advantages
for companies which do not incur substantial losses. Under the overall
limitation, a company averages together all of its foreign income and
taxes from all foreign countries. Thus, it has been noted that an indi-
vidual or company which annually pays taxes in one foreign country
at a rate higher than the U.S. tax rate (and thus would have some tax
credits disallowed under the per-country limitation) is able to average
those taxes with any taxes which might be paid at lower rates in other
foreign countries when applying the overall limitation. The result is
that a taxpayer can use more of the taxes paid in high tax countries
as credits against U.S. tax on foreign income under the overall limita-
tion if he also has income from relatively low-tax countries against
which the highly taxed income can be averaged.6
(b) Less dercloped country corporations.-Under present law, the
amount of dividends from a less developed country corporation in-
cluded in income by the recipient domestic corporation is not increased
(i.e., grossed up) by the amount of taxes which the domestic corpo-
ration receiving the dividend is deemed to have paid to the foreign
government. Instead the amount of taxes is reduced by the ratio of
the foreign taxes paid by the less developed country corporation to its
pretax profits.
It is contended that the failure to gross up the dividend by the
amount of the foreign taxes attributable to the dividend results, in
effect, in a double allowance for foreign taxes. It is argued that the
amount paid in foreign taxes not only is allowed as a credit in com-
puting the U.S. tax of the corporation receiving the dividend, but
also is allowed as a deduction (since the dividends can only be paid
6 For example, a company earning $100 each in countries A & B and
pain $ .60 in tax in A on that income and $30 in tax in B could use
all $90 in foreign taxes under the overall limitation (the limitation
would be 48 percent of $200 or $96). Under the per-country limitation
only $48 of the taxes paid to country A would be. creditable, thus
limiting total credits to $78.

out of income remaining after payment of the foreign tax).7 The
result, it is noted, is that the combined foreign and U.S. tax paid by
the domestic corporation is less than 48 percent of the taxpayer's
income in cases where the foreign tax rate of tre less developed
country corporation is lower than the 48-percent U.S. corporate tax
rate (but not zero or lower). It is also pointed out that in cases where
the foreign tax rate exceeds 48 percent, the dividend does not bring
with it all the foreign taxes that were paid and thus the size of foreign
tax credit carryover is reduced.
(c) Treatnment of capital gy'4ns-A number of questions have been
raised with respect to the present treatment of capital gains income
under the foreign tax credit as a result of the fact that capital gains
are taxed differently than ordinary income. In many cases the source
of income derived from the sale or exchange of an asset is determined,
if the asset is personal property, by the place of sale. It is pointed out
that in these cases, taxpayers presently can often exercise a choice
of the country from which the income from the sale of tangible per-
sonal property is to be derived.
Since, many foreign countries do not tax any gain from sales of
personal property, and most countries that do tax these gains do not
apply the tax to sales by foreigners, it is argued that the present sys-
tem permits taxpayers to plan sales of their assets in such a way so
that the income from the sale results in little or no additional foreign
taxes and yet the amount of foreign taxes usable as a credit against
U.S. tax liability is increased.
Another aspect of present capital gains taxation that is of concern
to some is that the credit limitations are not adjusted to reflect the
lower tax rate on capital gains income received by corporations.8 Under
7 For example, assume that a foreign country imposes a 30-percent
tax on $1,000 of income. If the foreign corporation earns $1,000 as a
less developed country corporation in that country, a distribution by
thliat corporation of the remaining $700 to its U.S. parent corpora-
tion would result in $700 income to the U.S. pa rent. The parent's
U.S. tax would be $336 before allowance of a foreign tax credit. In
calculating the foreign tax credit, the $300 amount of foreign taxes
paid would be reduced by 300/1000 to $210. The $210 could then be
credited against U.S. tax liability of $336, leaving a net liability of
$126. Thus, combined U.S. tax and foreign tax liability on the orig-
inal $1,000 of income would be. .426 ($300 foreign taxes plus $126
U.S. tax), not the $480 which would be paid at a 48-percent rate.
If that same foreign corporation earning .1.000 were not a les. de-
veloped country corporation, the entire $1.000 would be included in
the parent corporation's income if it received a dividend of $.700
which would carry with it foreign taxes of $300. In this c;pse, the
U.S. tax before credit would be .4S0. The entire (300 of foreiorn taxes
would be credited, leaving a U.S. tax liability of ?10. The com-
bined .*S. tax and foreign tax liabilities would be .10o.
8 A similar problem exists to a much lesser extent for capital gains
income of individuals under the alternative tax (sees. 1201 (b) and


present law, corporations having a net long-term capital gain in most
instances pay only a 30-percent rate of tax on that gain. But for pur-
poses of determining foreign source and worldwide income in the
limiting fraction of the foreign tax credit limitation, income from
long-term capital gains is treated the same as ordinary income (i.e.,
as if it were subject to a 48-percent rate of tax).9 Similarly, a taxpayer
who has a capital gain income from U.S. sources and has foreign
source income that is not capital gain income does not receive a full
credit for the amount of U.S. tax attributable to foreign source
House Bill
The Ways and Means Committee decided not to adopt any new
limitation on the amount of allowable foreign tax credits. Instead,
the committee referred the subject to a task force for further study.
However, a number of important provisions providing for changes
in the method of computation of the foreign tax credit were included
in the House bill. These are outlined below.
Under the House bill the per country limitation on the foreign
tax credit would be repealed in general for taxable years ending after
December 31, 1975.
A 3-year post ponement of this rule (until taxable years ending after
December 31, 1978) would be provided by the House bill for domestic
mining corponrat ions engaged in the extraction of minerals outside the
United States or its possessions for less than 5 years, that have sus-
tained losses in at least 2 of these years, that have 80 percent of their
gross receipts from the sale of such minerals, and that have made
commitments for substantial expansion of their foreign mineral
extraction activities.
The repeal of the per country limitation provided by the House bill
does not apply to income derived from sources within the possessions
of the United States. (Sec. 1031)
Foreign losses which arise on an overall basis would under the
House bill be required to be offset against U.S. income when, and to the
extent, foreign income is earned in future years. This provision would
apply to losses incurred in taxable years beginning after December 31,
9 For example, if a corporation has worldwide income of $20 mil-
lion, $10 million of which is ordinary income from sources within the
United States and $10 million of which is income from the sale of an
asset from sources without the United States, that corporation is al-
lowed a foreign tax credit equal to one-half (10/20) of his U.S. tax
liability, even though only $3 million of the $7.8 million in U.S. tax
liability is attributable to foreign source income. Present law thus
favors the taxpayer with a foreign source capital gain since his U.S.
tax on U.S. ordinary income of $10 million is not $4.8 million but is
$3.9 million.
:' For example., if suhli a taxpayer had $10 million of U.S. source
capital gain and -'10 million of foreign ordinary income, the foreign
tax credit limitation would limit the credit to $3.9 million even though
he would be liable for $4.8 million of U.S. tax on his foreign source


1975. However, this recapture rule would not apply to losses incurred
in a possession of the United States, in taxable years beginning before
January 1,1981. (Sec. 1032)
Dividends received by U.S. shareholders from less-developed coul-
try corporations would under this House bill be required to be "grossed
up" by the amount of taxes paid to less-developed countries for pur-
poses of computing the foreign tax credit and the related foreign
source taxable income. (Sec. 1033)
Any capital gain from property sold outside of the country in which
a company does most of its business (or outside the country of residence
of the individual) under the House bill would not be treated as foreign
source income for purposes of the foreign tax credit limitation, if no
substantial foreign tax has been paid on that income. New rules would
be provided for netting foreign source capital gains and losses with
domestic source capital gains and losses in computing the foreign tax
credit limitation. Amounts to be included in the limitation would be
adjusted for the lower corporate tax rate on capital gains income.
(Sec. 1034)
Finally, under the House bill a carryback would be allowed to any
taxable year ending in 1975, 1976, or 1977 for certain extraction taxes
which would otherwise be disallowed with respect to foreign oil and
gas extraction income. (Sec. 1035)
4. Amendments Primarily Affecting Individuals
A. Exclusions for Income Earned Abroad
Present Law
U.S. citizens are generally taxed by the United States on their
worldwide income, with the provision of a foreign tax credit for
foreign taxes paid. However, U.S. citizens who work abroad may
exclude from their income up to $20,000 of earned income for periods
during which they reside outside of the United States for 17 out of
18 months or during the period they are bona fide residents of foreign
countries (sec. 911). In the case of individuals who have been boila
fide residents of foreign countries for three years or more, the exclu-
sion is increased to $25,000 of earned income. Currently, approxi-
mately 100,000 U.S. citizens file returns excluding income from tax
under this provision. These exclusions do not apply to amounts paid
by the U.S. Government to its employees who work abroad.
A separate exclusion from gross income (sec. 912) is provided for
certain statutory allowances paid to civilian employees of the United
States Government who work in foreign countries and. in certain in-
stances, in the States of Hawaii and Alaska and in the territories and
possessions of the United States. Some of the allowances would, in the
absence of the specific exclusion, nevertheless be excluded from income,
in whole or in pairt, under other provisions of the tax laws. Others
are amounts for which the employee iniy 1-e entitled to a deduction
in computing taxable income.
Iss1 oes
The present exclusions have been opposed on the grounds that they
result in a U.S. income tax -alvin!_s for an individual involved in


those cases where the excluded income of the U.S. citizen is not taxed
at all by any foreign country or is taxed at a lower foreign rate
than that otherwise imposed by the United States. Those with this
view consider this treatment unfair to others who reside in this coun-
try and pay the regular income tax.
It is also argued that additional income tax savings can be obtained
if foreign taxes are paid on the excluded income because those taxes
can be credited against any U.S. tax on any foreign source income
not qualifying for the $20,000 (or $25,000) exclusion. It is noted that
the effect of this is to provide a foreign tax credit on income which
has not been subjected to double taxation and thus to provide in effect
a double benefit.
Questions have also been raised as to the appropriateness of the
exclusion for allowances paid to U.S. Government employees serving
abroad on much the same grounds as the objections to the exclusions
for private employees.
Homse Bill
The $20,000 exclusion (or in certain instances, $25,000) for income
earned abroad by U.S. citizens living or residing abroad would be
phased out under the House bill over a 4-year period, by lowering the
exclusion by $5,000 (or $6,250) each year. However, the $20,000 exclu-
sion would be retained for employees of U.S. charitable organizations
(section 501(c) (3) organizations). In addition, employees working on
construction projects (other than oil or gas wells) would continue
to receive the $20,000 exclusion for taxable years beginning in 1976,
1977, and 1978. In those cases where the full exclusion is not available,
a deduction of up to $1,200 would be provided for elementary and sec-
ondary school expenses of dependents of U.S. taxpayers employed out-
side the United States. An exclusion from gross income would also be
provided for amounts paid for municipal-type services furnished in a
foreign country by an employer on a nondiscriminatory basis. Present
law would also be modified to allow a foreign tax credit to individuals
claiming the standard deduction. These provisions would apply to tax-
able years beginning after December 31,1975. (Sec. 1011).
The House bill does not deal with the exclusion of allowances paid to
governmental employees serving abroad. It was decided to defer any
action on this provision until an inter-agency task force of the Execu-
tive branch could complete a study on the governmental allowances
which they were then preparing.
B. U.S. Taxpayers Married to Nonresident Aliens
Present Law
Under present law, a husband and wife may file a single income tax
return even though one of the spouses has no gross income or deduc-
tions. However, this joint return may not be made if either the hus-
band or the wife at any time during the taxable year is a nonresident
It has been pointed out that the inability of a husband and wife to
file a joint return where one of them is a nonresident alien has re-

suited in the possibility of a heavier tax burden being placed upon
this group of taxpayers than other married taxpayers. For example,
even though a joint return is not allowed, the spouse who files a tax
return is required to use the rate brackets of married individuals fil-
ing separately. In addition, these married individuals cannot obtain
the benefits of the 50-percent maximum tax on earned income because
married taxpayers must file a joint return in order to obtain the bene-
fits of that provision.
House Bill
U.S. taxpayers married to nonresident aliens would under the House
bill be permitted to file joint returns with their spouse if an election
is made by both taxpayers to be taxed on their worldwide income and
if the taxpayer makes available the necessary books and records. This
provision would apply to taxable years ending on or after Decem-
ber 31, 1975. Community property laws for income tax purposes would
not apply to taxpayers married to nonresident aliens whether or not
they make this election. This provision would apply to taxable years
beginning after December 31,1975. (Sec. 1012).

C. Treatment of Foreign Trusts and Excise Tax on Transfers of
Property to Foreign Persons
Present Law
Under present law, the income of a trust is taxed basically in the
same manner as the income of an individual, with limited exceptions
(sec. 642). Just as nonresident alien individuals are generally taxed
only on their U.S. source income other than capital gains and on their
income effectively connected with a U.S. trade or business (and not
on their foreign source income), so any trust which can qualify as
being comparable to a nonresident alien individual is generally not
taxed on its foreign source income. If a trust is taxed in a manner
similar to nonresident alien individuals, it is considered (under see.
7701 (a) (31)) to bea foreign trust.1
If a U.S. taxpayer is a beneficiary of a foreign trust, distributions
to him are generally taxed in the same manner as are distributions to
a beneficiary of a domestic trust. Any accumulation distributions are
subject to throwback rules, under which the amount of tax to be
paid by the beneficiary is determined by the tax bracket of the bene-
ficiary in the year the trust originally earned the income rather than
the year the income was distributed. However, in the case of an ac-
cumulation distribution by a foreign trust which was created by a

The Internal Revenue Code does not specify what characteristics
must exist before a trust is treated as being comparable to a nonre'sident
alien individual. However, Internal Revenue Service rulings and court
cases indicate that this status depends on various factors, such as the
residence of the trustee, the location of the trust assets. the count ary
under whose laws the trust is created, the nationality of the grantor.
and the nationality of the beneficiaries. If an examination of tlihe fac-
tors indicates that a trust has sufficient foreign contacts, it is delenod
comparable to a nonresident alien individual and thus is a foreign


U.S. person, any capital gains income earned by the trust is treated as
distributed pro rata with other income (and taxed at favorable capi-
tal gains rates to the beneficiary), while in the case of these distribu-
tions by domestic trusts, capital gains income is treated as distributed
only after all other income is distributed.
In addition to the above provisions which govern the taxation of
foreign trusts, present law imposes (sec. 1491) an excise tax of 2/2
percent on certain transfers of property to foreign trusts, as well as to
foreign corporations (if the transfer is a contribution of capital)
and to foreign partnerships. Under present law, the excise tax is im-
posed on transfers of stock or securities to such an entity by a U.S.
citizen, resident, corporation, partnership or trust. The amount of
the excise tax is equal to 271/2 percent of the amount of the excess of
the value of the stock or securities over its adjusted basis in the hands
of the transferor.

The rules of present law permit U.S. persons to establish foreign
trusts in which funds can be accumulated free of U.S. tax. In addition,
the funds of these foreign trusts are generally invested in countries
which do not tax interest and dividends paid to foreign investors, and
the trusts generally are administered through countries which do not
tax such entities. Thus, these trusts generally pay no income tax any-
where in the, world. Although the beneficiaries are taxed (and the
throwback rules are applied) upon any distributions out of these
trusts, nevertheless it is contended that it is unfair to permit a grantor
by using a foreign trust to provide a tax-free accumulation of income
while the income remains in the trust.
Little information is known about the value of assets held in foreign
trusts, but some experts have concluded that $5 to $10 billion would not
be an unreasonable estimate. Many believe this trend was accelerated
by the introduction of legislative proposals to tax the earnings of for-
eign trusts to the grantor of the trust. This point of view assumes that
the acceleration occurred because of the belief that any new rules tax-
ing the grantors of foreign trusts would not apply to trusts established
prior to the enactment of the legislation. It has been reported that
based upon this expectation, one law firm established over 200 trusts
for its clients.
Finally, some believe the excise tax on certain transfers to foreign
trusts and other foreign entities may not be effective in preventing
U.S. taxpayers from transferring appreciated property to foreign
trusts or other entities without payment of a full capital gains tax.
It is noted that the excise tax of 271,, percent of the amount of appre-
ciation is less than the maximum capital gains tax on individuals
(which can be 'as high as 35 percent). Furthermore, the excise tax pro-
vision has been interpreted to exclude transfers to foreign entities to
the extent that the entity prove ides some consideration to the transferor.
It is argued that this enables a U.S. taxpayer to transfer appreciated
stock to a trust established by him and receive in return from the trust
a private annuity contract or other deferred payment obligation. In

any sLuch case, it is noted that the transferor will pay U.S. tax on the
gain only as the deferred payments are received and will have the
benefit of the tax-free accumulation of income from the property trans-
ferred (or from the proceeds of any sale of the property by the trust).
House Bill
U.S. grantors of foreign trusts with U.S. beneficiaries under the
House bill would be taxed currently on the income of these trusts
under the grantor trust rules of present law. This provision would
apply to trusts created after May 21, 1974 and to transfers of property
to foreign trusts after May 21, 1974, in taxable years ending after
December 31,1975. (Sec. 1013)
In all other cases U.S. beneficiaries of foreign trusts would under
the House bill pay interest charges on the U.S. taxes on any accumula-
tion distributions which are subject to U.S. tax. The interest charge
would apply to distributions made after December 31, 1975. (Sec. 1014)
Finally, under the House bill the excise tax on transfers of stocks
and securities to foreign entities would be extended to transfers of all
other types of property. This tax would apply only to the unrealized
al)preciation. The rate of this tax would be increased from 271/ to
35 percent. These changes would apply to transfers m.iade after
October 2, 1975. (Sec. 1015)
5. Money or Other Property Moving In or Out of the United States
A. Investments by Foreigners in the United States
P'( SChit Law
Present law provides, in general, that interest, dividends and other
similar types of income of a nonresident alien or a foreign corpora-
tion are subject to a 30 percent tax on gross amount paid, if such
income or gains are not effectively connected with the conduct of a
trade or business within the United States (see:.. 871 (a) and 881). This
tax is generally collected through withholding by the person making
the dividend or interest payment to the foreign recipient of the income
(.ecs. 1441 and 1442). For this reason the tax is commonly referred to
as a withholding tax. However, in the case of interest, a number of
exemptions have been provided from this 30-percent tax on the gro:-s
amount. Interest from deposits with persons carrying on the bakling
business are exempt (sees. 861(a) (1) (A) and 861(c)). Any intere-t
and dividends paid by a domestic corporation which earns less than 20
percent of its gross income from sources within the United States(, is
also not. subject to the 30 percent tax (sees. 861(a) (1) (B) and 861(a)
(2) (A)).
In addition to the above exemptions provided in the Internal Reve-
nue Code, the United States has a number of tax conventions in effect
which provide for either an exemption or a reduced rate of tax for
interest, and dividends paid to foreign persons if the income is not
effectively connected with the conduct of a trade or business within the
United States.


For a number of reasons many believe that interest and dividends
paid to nonresident aliens and foreign corporatioLns should be exempt
from U.S. tax. First, it is argued that the exemption on bank deposits
should be retained since amounts on deposit. in bank accounts could be
very easily transferred out of the United States in to foreign bank
accounts. It is also argued that a U.S. exemption for bond issues of U.S.
corporations sold to foreign lenders would lessen the administrative
burden and cost to U.S. borrowers without resulting in any significant
inroad on the revenues since most of these issues are exempt today. Fur-
ther it is argued that a broad exemption covering all portfolio interest
income would increase the supply of capital available to U.S. bor-
rowers and make U.S. borrowing competitive with foreign borrowing
which often is eligible for an exemption from tax.
House Bill
Under the House bill, the present exemption from the 30-percent
withholding tax which applies to foreign deposits held in U.S. banks
(which under present law would expire on December 31, 1976) is
made permanent. (sec. 1041)
B. Treatment of Reorganizations Involving Foreign Corporations
Present Law
Present law provides that certain types of exchanges relating to
the organization, reorganization, and liquidation of a corporation
can be made without recognition of gain to the corporation involved
or to their shareholders. However, when a foreign corporation is in-
volved in certain of these types of exchanges, tax-free treatment is
not available unless prior to the transaction the Internal Revenue
Service has made a determination that the exchange does not have
as one of its principal purposes the avoidance of Federal income taxes.
This determination is made by issuing a separate ruling for each
transaction. The required determination must be obtained before the
transaction in all cases unless the transaction involves only a change
in the form of organization of a second (or lower) tier foreign sub-
sidiary with no change in ownership.
In 1968, the Internal Revenue Service issued guidelines 12 as to
when favorable rulings "ordinarily" would be issued. As a condition to
obtaining a favorable ruling with respect to most transactions, the
section 367 guidelines require the taxpayer to agree to include certain
items in income (the amount to be included is called the section 367
toll charge). The amount required to be included in income generally
reflects untaxed accumulated earnings and profits (in the case of
transfers of property intothe United States), or the immediate poten-
tial earnings from liquid assets or the untaxed appreciation from
12 Rev. Proc. 68-23, 1968-1 Cum. Bull. 821.

passive investment assets (in the case of transfers of property out of
the United States).13
In addition to section 367, section 1248 provides for the imposition
of a U.S. tax on accumulated profits earned abroad when they are
repatriated to the United States in cases where gain is recognized on
the sale or exchange (or redemption) of stock of a controlled foreign
corporation held by a U.S. person owning 10 percent or more of the
voting stock. This provision is designed to terminate deferral on
the unrepatriated earnings of a foreign subsidiary when the earnings
are indirectly repatriated through the sale or liquidation of the
Itc s.Ic8
Many taxpayers have raised questions as to the operation of section
367 and section 1248. First, it is stated that the advance ruling require-
ment often results in an undue delay for taxpayers attempting to con-
sum mate perfectly proper business transactions. Second, it is indicated
that a number of cases have arisen where a foreign corporation was
involved in an exchange within the scope of the section 367 guidelines
without the knowledge of its U.S. shareholders, and thus no request
for prior approval was made. As a result, the shareholders were taxed
on the exchange despite thle fact that a favorable ruling would clearly
have been issued by the Internal Revenue Service had it been requested
prior to the transaction.
The third area where questions have been raised in the present
administration of section 3,67 concerns situations where the IRS re-
quires a U.S. shareholder to include certain amounts in income as a
toll charge even though there is no present tax avoidance purpose but,
rather, only the existence of a potential for future tax avoidance. In
certain of these cases the Internal Revenue Service only has the option
either of collecting an immediate tax or of collecting no tax at all
since the IRS has no authority to defer payment of the tax until the
time that the avoidance actually arises, except by entering into a
clo:-,i g agreement with the taxpayer.
13 For example, if a domestic corporation transfers property to a
foreign subsidiary corporation (a transaction otherwise accorded tax-
free treatment under section 351), the transaction will be given a
favorable ruling only if the domestic corporation agrees to include in
its gross income for its taxable year in which the transfer occurs an
appropriate amount to reflect realization of income or gain with
respect to certain types of assets (e.g., inventory, accounts receivable.
and certain stook or securities) transferred to the foreign corporation
ais p)art of the transfer. If the transaction involves. the liquidation of
a foreign corporation into a domestic parent, a favorable ruling will
be issued if the domestic parent agrees to include in its income as a
dividend for the taxable year in which tlhe liquidation oceiurs tlhe
portion of the accumulated Parnings and profits of the foreign cor-
poration which are properly attributable to the domestic corporation's
stock interest in the foreign corporation.


The necessity for obtaining the satisfaction of the IRS that no tax
avoidance is involved in a transaction results in a taxpayer having the
choice, of modifying a transaction as suggested by the IRS or not going
through with the transaction. Presently, there is no opportunity for
a taxpayer who disagrees with the IRS determination to obtain a court
review even if the taxpayer believes that the IRS has acted arbitrarily.
Many would like to resolve this problem by affording taxpayers who
wish to challenge an IRS determination the right to consummate the
transaction and have the issue resolved in the courts.
Finally, the section 1248 provision terminating deferral on the sale
of a foreign subsidiary applies only to taxable sales or exchanges. In
other situations it is pointed out that, for example, where the stock
of a foreign subsidiary is sold pursuant to a liquidation plan, the
section does not apply and no ordinary income tax is paid on the
untaxed foreign earnings.
Hoiw e bill
The House bill eliminates the requirement of present law under
section 367 that an advance ruling from the IRS be obtained for re-
organization-type transactions involving foreign corporations. For
transactions which are solely foreign or which involve the transfer of
property into the United States, the House bill provides that the IRS
is to draft regulations by January 1, 1978, specifying the treatment of
these transactions. For transfers of property out of the United States,
individual rulings would still be required but these rules could be re-
quested up to 183 days after the beginning of the transaction. In addi-
tion, these rulings would be subject to Tax Court review. Finally, the
provision of present law which taxes as ordinarily income the sale of
stock in a foreign subsidiary (to the extent of accumulated earnings)
would be extended to apply to nontaxable transfers of stock (Code sec-
tions 311,336, and 337).
These provisions would apply generally to exchanges beginning
after October 9, 1975, and to sales, exchanges and distributions takingo-
place after such date. The provision relative to Tax Court review
would apply with respect to pleadings filed with the Tax Court after
the date of enactment of this legislation but only with respect to
exchanges beginning after October 9, 197'. (Sec. 1042)

C. Contiguous Country Branches of Domestic Insurance
Present law
Under present law, a domestic mutual life insurance company is
subject to tax on its worldwide taxable income. If the company pays
foreign income taxes on its income from foreign sources it is allowed
a foreign tax credit against its otherwise payable U.S. tax on foreign
source income.

Since the beginning of this century, U.S. mutual life. insurance
companies have. been engaged in the. life insurance business in Canada.
At the present time, the tax imposed by tihe United States on the op-
erations of Canadian branclies of U.S. mutual life insurance corn-


panies generally exceeds the tax imposed by the Dominion of Canada
and its provinces.
The income of the companies from their Canadian operations is
derived generally by the issuance of policies insuring Canadian risks
and the inves.tiient income from the policyholder reserves on the
Canadian risks and any surplus. Quite often the invowtinents of the
Canadian branch are in Canadian securities. A separate branch account
is maintained by the life insurance companies under which the various
income, expense, asset, reserve and other items that relate to Canadian
policyholders are segregated on the books of the company. The sepa-
rate branch accounting system is used for purposes of establishing
premiums and policyholder dividend rates based upon the :-.parate
mortality and earnings experience of the Canadian branch.
The income earned by the Canadian branch inumres solely to the
benefit of these Canadian policyholders and is reflected either by divi-
dends paid to them, reductions in the cost of insurance, or increases in
the size of the reserves and surplus with respect to Canadian policy-
holders. Thus, it is argued that the additional cost to the
company resulting because U.S. tax liability exceeds Canadian
income tax liability on the Canadian branch profits falls primarily
upon the Canadian policyholders, since it reduces the reserves and
surplus available to the Canadian policyholders. It is contended that
this tax treatment makes it more difficult to issue mutual life insurance
policies in Canada.
Similar tax problems are faced by U.S. stock life companies who
compete in Canada for business under terms that are substantially
the same as mutual companies.
House Bill
Mutual life insurance companies maintaining separate operations in
countries contiguous to the United States would under the House bill
be permitted to treat these operations as if carried on through a foreign
subl)sidiary. A mutual company would be treated as having transferred
its assets to such a branch operating in the contiguous country and
would be subject to the normal tax requirements (of Code section 367)
regarding transfers of property out of the United States for tangible
property assets except that losses would be netted in deterring tihe
gain from these assets. In addition, stock life insurance companies
would be permitted to transfer the assets of their foreign branch opera-
tions in contiguous countries to foreign subsidiaries tinder these same
section 367 rules. This provision would apply to taxable years begin-
ning after December 31, 1975. (Sec. 1043)
D. Transitional Rule for Bond, etc., Losses of Foreign Banks
Pre..ent Law
The Tax Reform Act of 1969 (P.L. 91-172) eliminated the preferen-
tial treat iiient accorded to certain tra nations of financial institutions
involving corporate and government bonds and other evidence of in-
debtedness. Previous to that tliese financial institutions were allowed
to treat net gains from these transactions a- capital gains and to de-
duct the losses as ordinary losses. The 1969 Act provided parallel
treatiiient to gains and losses pertaining to these t raiu-actions by treat-


ing net gains as ordinary income and by continuing the treatment of
net losses as ordinary losses. The ordinary income and loss treatment
provided under the 1969 Act was also applied to corporations which
would be considered banks except for the fact that they are foreign
corporations. Previous to the 1969 Act, these corporations had treated
the above-described transactions as resulting in either capital gains
or capital losses.
Some of the corporations which would be considered banks except
for the fact that they are foreign corporations had capital loss carry-
overs predating the 1969 Act. However, any post-1969 gains realized
by these corporations resulting from the sale or exchange of a bond,
debenture, note, or other evidence of indebtedness is accorded ordinary
income treatment. Thus, these corporations are left with capital loss
carryforwards which, under present law, cannot be applied against
any gains resulting from the same type of transactions which previ-
ously generated such losses.
House Bill
Foreign banks would be provided the same transition rule as applies
presently to domestic banks with respect to the sale or exchange of a
bond, debenture, note or certificate or other evidence of indebtedness.
This provision would apply generally to taxable years beginning after
July 11, 1969. (Sec. 1044)

6. Special Categories of Corporate Tax Treatment

A. Western Hemisphere Trade Corporations
P,'e-sent Law
Under present law, domestic corporations called "Western Hemi-
sphere Trade Corporations" (WHTCs) are entitled to a deduction
which may reduce their applicable corporate income tax rate by as
much as 14 percentage points below the applicable rate for other do-
mestic corporations.14
A domestic corporation must meet three basic requirements to qual-
ify as a WHTC. First, all of its business (other than incidental pur-
chase.s) must be conducted in countries in North, Central or South
America or in the West Indies. Second, the corporation must derive at
least 95 percent of its gross income for the 3-year period immediately
precedinI the close of the taxable year from sources outside the United
States. Third, at least 90 percent of the corporation's income for the
above period must be derived from the active conduct of a trade or
business. The above requirements are intended to insure that the cor-
poration is engaged in an active trade or business outside the United
States, but within the Western Hemisphere.

Questions have been raised as to whether there is any longer any
basis for continuing the preferential tax treatment provided WHTCs.
14 The deduction (see. o9- of the Code) is canal to taxable income
multiplied by 14 over the corporate tax and surtax rates.


It is noted that in any event the benefit of this treatment is no longer
significant in many cases because the taxes which are now imposed by
the Western Hemisphere Trade countries approach or equal those im-
posed in the United States. It is also pointed out that under the broad
interpretation given the WHTC provisions by the Service, corpora-
tions can often obtain the benefits of the provisions for goods manu-
factured outside the Western Hemisphere by causing title to the goods
to pass within the Western Hemisphere. Chiefly, however, it is argued
that this is discriminatory treatment which no longer serves any na-
tional purpose.
House Bill
The provision of present law which permits a 14-percent lower tax
rate for Western Hemisphere Trade Corporations would under the
House bill be phased out over a 5-year period, according to the follow-
ing table:
The percentage
For a taxable year beginning in- 1cou1l be-
1976 --------------------------------------------------------------11
1977 --------------------------------------------------------------- 8
1978 ---------------------------------------------------------------5
1979 ---------------------------------------------------------------2
Thus, the Western Hemisphere Trade Corporation provisions would
be repealed with respect to taxable years beginning after December 31,
1979. (Sec. 1052)

B. Corporations Conducting Business in Possessions
Present Law
Under present law, corporations operating a trade or business in a
possession of the United States are entitled to exclude from gross in-
come all income from sources without the United States, including for-
eign source income earned outside of the possession in which they con-
duct business operations, if they meet two conditions. First, 80 percent
or more of the gross income of the corporation for the 3-year period
immediately preceding the close of the taxable year must be derived
from sources within a possession of the United States. Second, 50 per-
cent of the gross income of the corporation for the same 3-year period
must be derived from the active conduct of a trade or business within
a possession of the United States.
Any dividends from a corporation which satisfies thes-,e requirements
are not eligible for the intercorporate dividends received deduction.
This deduction, however, is allowed if the corporation did not sat-
isfy these requirements in the current and preceding taxable year. In
addition, since a corporation meeting the requirements of section 931
is a domestic corporation, no gain or loss is recognized to a parent
corporation if it liquidates a possessions corporation (under section
The exclusion of possessions income applies to corporations conduct-
ing business operations in the Commonweolth of Puerto Rico and all
possessions of the United States (Guam, the Canal Zone, and Wake
Island) except the Virgin Islands. The exclusion also applies to busi-
ness operations of individuals in possessions but not to Puerto Rico or
to the Virgin Islands and Guam.


Tlhe special exemption provided in conjunction with investment
incentive programs established by possessions of the United States,
especially the Commonwealth of Puerto Rico, has been used as an
inducement to U.S. corporate investment in active trades and businesses
in Puerto Rico and the possessions. Under these investment programs,
little or no tax is paid to the possessions for a period as long as 10 to 15
years and no tax is paid to the United States as long as no dividends
are 1)aid to the parent corporation.
Because no current U.S. tax is imposed on the earnings if they are
not repatriated, it is pointed out the amount of income which accumu-
lates over the years from these business activities can be substantial.
It is also noted that the amounts which may be allowed to accumulate
are often beyond what can be profitably invested within the possession
where the business is conducted. As a result, corporations generally in-
vest this income in other possessions or in foreign countries either
directly or through possessions banks or other financial institutions. In
this way, it is claimed possessions corporations not only avoid U.S. tax
on their earnings from businesses conducted in a possession, but also
avoid U.S. tax on the income obtained from reinvesting their business
earnings abroad.
It is a strongly held view of the Government of Puerto Rico that
the possessions investment incentives play a key role in keeping invest-
ments in the possessions competitive with investments in neighboring
countries. It points out that the UT.S. Government imposes upon Puerto
Rico, for example, various requirements such as minimum wage re-
quirements and requirements to use U.S. flag ships in transporting
goods between the United States and Puerto Rico. These requirements
substantially increase the labor, transportation and other costs of es-
tablishing business operations in Puerto Rico. Thus, without signifi-
cant local tax incentives that are not nullified by the UT.S. tax law, it is
argued that the Commonwealth of Puerto Rico would find it quite
difficult to attract investments by U.S. corporations.
However, it is recognized that investing the business profits of these
possessions corporations outside of the possession where the business
is being conducted does not contribute to the economy of that posses-
sion either by creating new jobs or by providing capital to others to
build new plantS and equipment. Accordingly, it is suggested that
while it may be appropriate to provide preferential treatment for in-
vestminent in the possessions as contrasted to investment in a foreign
comintr', it is not appropriate to provide a preference for income
earned from investments outside of the possession. The denial of a
dividends received deduction to the U.S. parent corporation tends to
c(aispe the Iossessions corporation to invest earnings abroad until liqui-
dation (uTually upon termination of the local tax exemption), at which
time the earnings can be returned to the United States tax free. These
profit s derived outside of the possession could be made siil)bjet to U.S.
tax if the possessioiis corporationn were given tlhe alternative of re-
turning the profits to the United States prior to liqui(lation without
1)payment of ,ny U.S. tax.
A second set of difficulties under present law stems from the rela-
tionship of tlhe possessions corporation provision. to the provisions


relating to tlhe filing of consolidated tax returns. Domestic corpora-
tions which arc affiliated usually file a. consolidated tax return. Among
the benefits of a consolidated tax return is the opportunity to offset the
losses of one corporation against the income of other corporations. A
corporation which is entitled to the benefits of the possessions
corporation exclusion may not participate in the filing of a consoli-
dated return. However, the courts have determined that possessions
corporations may join in the filing of consolidated returns in years in
which they incur losses. As a result, it is argued these corporations can,
in effect, obtain a double benefit. Not only is the possessions and other
foreign source income of these corporations excluded from U.S. tax-
able income, but losses of possessions corporations can, by filing a coin-
solidated return, reduce U.S. tax on the U.S. income of related corpora-
tions in the consolidated group.
House B il
The tax treatment of p)o-sessions corporations would be modified
by the House bill by providing a new tax credit for such corporations
in lieu of the income exclusion provided under prez-,nt law. The tax
credit would equal the U.S. tax attributable to a corporation's income
from a possessions trade or business and from qualified possessions
investments. Other income of a possessions corporation would be sub-
ject to U.S. tax. U.S. corporations receiving dividends from poss,-,ions:
corporations would be eligible for the 85- or 100-percent dividends-
recived deduction. Corporations would qualify as possessions corpo-
rations only if they elect for a period of 10 years to remain in that
status. These provisions would apply to taxable years beginning after
December 31, 1975. (sec. 1051)

C. China Trade Act Corporations
Prof'-'rC) Lawv.
Und(ler preent.t law, a China Trade Act Corporation ("CTA corpora-
tion") and its shareholders are entitled to special tax benefits. Under
these prov-isions, a CTA corporation is subject to the same tax rates
as a domestic corporation, but. upon meeting certain requllirelients, is
allowed a special deduction which can completely eliminate any in-
come subject to tax (sec. 941).
The special deduction is allowed against taxable income derived
from sources within Formnosa and Hong Kong in the proportion which
the par value of stock held by residents of Formos.,. Hong Kong. the
United States. or by individual citizens of thie United States, wherever
resid(lent. bx.ars to the par value of all outstanding stock. Thus, where
all the shareholders of the CTA corporation are either U.S. citizens or
residents of Hong Kong, Formiosa. or the United State-,:. and all of the
corporation's income is derived within thong Konz :11dl Formosa,.
the special deduction would equal and thereby elinii-i.rto the IaIxtIble
income of the corl)or.ltiol.
The spl,.ial d(le(luction is limited by .) r(quirelient tlihIt a dividend
must bN paid in an amount at lea.t equal to the amount of F(ed oral tax
that would be (due weiv it not for the spivial (ledu(iction. The "special
d(ivid(lend" iin:st 1)e pi)id to sto(kholder'- who. on tie lai-, d; Iv of the tax-
;ible year, were resd(lent in Formosa;i. loing Kong, or wore either resi-


dents or citizens of the United States. For example, if the taxable in-
come before the special deduction were $100,000 in 1974, the special
dividend would have to equal at least $41,500 (22 percent of the first
$25,000 plus 48 percent of the remaining $75,000). In this example,
upon payment of the special dividend of $41,500, the CTA corporation
deriving all of its taxable income from sources within Hong Kong and
Formosa ($100.000) would be entitled to a special deduction in an
amount equal to its taxable income, i.e., $100,000. The special dividend
deduction enables the CTA corporation to operate free of tax.15
In addition special benefits are accorded to the shareholders of a
CTA corporation. Dividends paid by a CTA corporation to share-
holders who reside in Hong Kong or Formosa are not includable in the
gross income of the shareholder (sec. 943). This applies to all divi-
dends paid to Hong Kong or Formosa resident shareholders, regard-
less of whether they are regular or special dividends.
It is contended that the combination of benefits granted to CTA
corporations and their shareholders is unprecedented. For example, if
in a given year a CTA corporation, whose shareholders are U.S. citi-
zens residing in Hong Kong or Formosa, has $500.000 of taxable in-
come and pays a special dividend of at least $233,500 to its share-
holders, neither the corporation nor its shareholders will incur any
U.S. tax liability, whereas a domestic corporation and its shareholders
in this situation (assuming marginal tax brackets of 50 percent for
the shareholders) would incur respective U.S. tax liabilities of $233.500
and $116,750. The tax savings to the CTA corporation and its share-
holders in the above example would be $350,250. If the balance of the
earniings of the CTA corporation were paid out, the tax savings would
be even greater.
It is argued that the original purpose of the China Trade. Act. that
of expanding trade with China, is no longer being served by the very
favorable tax advantages it provides. Moreover, there are innumerable
U.S. companies currently trading in Hong Kong and Formosa with-
out the extensive tax benefits provided by the China Trade Act.
House Bill
The provisions of present law permitting special tax treatment for
China Trade Act Corporations and their shareholders would be phased
out over a 4-year period, according to the following table:
Thie prcentoge
For a taxable year beginning in- reduction would br-
1976------------------------------------------- 5-------
1977 ------------------------------------------------ 50
1978-------------------------------------------------- 75
Thus, the China Trade Act Corporation provisions would be repealed
with respect to taxable years beginning after December 31, 1978.
(See. 1053)
15 The CTA corporation is not entitled to the foreign tax credit (sec.
942) but is entitled to the deduction of all foreign taxes paid with re-
spect to taxable income derived from surces within Hong Kong or
Formosa (sec. 164).


7. Domestic International Sales Corporations (DISCs)
Pre.sent Law
Present law provides for a system of tax deferral for a corporation
known as a Domestic International Sales Corporation. or a "DISC",
and its shareholders. Under this tax system, the profits of a DISC are
not taxed to the DISC but are taxed to the shareholders of the DISC
when distributed to them. However, each year a DISC is deemed to
have distributed income representing 50 percent of its profits, thereby
subjecting that income to current taxation in the shareholders hands.
In this way the tax deferral which is available under the DISC pro-
visions is limited to 50 percent of the export income of the DISC.
To qualify as a DISC, at least 95 percent of the corporation's assets
must be export related and at least 95 percent of a corporation's gross
income must arise from export sale or lease transactions and other
export-related activities (i.e.. qualified export receipts). Qualified ex-
port receipts include receipts from the sale of export property, which
generally means property such as inventory manufactured or pro-
duced in the United States and held for sale for direct uis. consump-
tion or disposition outside the United States. The President has the
authority to exclude from export property any property which he
determines (by Executive order) to be in short supply. However,
energy resources such as oil and gas and depletable mineralns are auto-
matically denied DISC benefits under the Tax Reduction Act of 1975.
That Act also eliminated DISC benefits for products the export of
which are prohibited or curtailed under the Export Administration
Act of 1969 by reason of scarcity.
If a DISC fails to meet the qualifications for any reason, the DISC
provisions provide for an automatic recapture of the DISC benefits
received in previous years. This recapture is spread out over the num-
ber of years for which the corporation was qualified as a DISC but
may not exceed 10 years.
Those who favor the retention of the DISC provisions believe that
DISC was enacted to enable U.S. manufacturers to increase their ex-
ports and that DISC has accomplished what it set out to do. Since
the enactment of DISC in 1971, exports have increased from $43 bil-
lion to $107 billion for 1975. This is an increase of 250 percent. Al-
though recognizing that other factors have played a significant role in
the increase of U.S. exports, advocates of DISC conclude that a sig-
nificant role in this increase has also been played by DISC.
It is argued that DISC increases U.S. exports in a number of ways.
First, it enables U.S. manufacturers to reduce their prices to meet
foreign compet ition. This assistance, is necessary to counter the variety
of ways in which foreign competitors receive export assistance from
their governments (such as the rebate of value added taxes). Second,
to the extent prices are not lowered, DISC provides increased funds
to U.S. exporters to finance their export sales. Third. DISC provides
funds to U.S. companies to expand their production facilities (which
increases U.S. employment) for export sales. Finally, the existence of
the DISC program indicates the importance which tlie. Federal Gov-
ernment places upon export sales. Its repeal could be taken as a signal


that the Federal Government no longer considers exports to be
Advocates for the retention of DISC argue that increasing export
sales is beneficial to the U.S. economy in a number of ways. First, it is
argued that export sales create employment in U.S. industry which
would be lost but for the export sales. Additionally, it is argued that
increased exports helps the U.S. balance of payments by providing
the foreign currency which is essential to enable U.S. industry and
U.S. consumers to import high-priced foreign oil.
It is also argued that without DISC it would quite often be neces-
sary to manufacture abroad rather than in the United States, since
DISC is designed to equalize the treatment with U.S. firms with for-
eiogn subsidiaries. Manufacturing abroad would result in incomes taxes
paid to foreign governments rather than the United States; employ-
ment. for foreign individuals rather than for U.S. individuals; and the
loss of positive balance of payments inflow from export sales. Thus.
it is argued that the repeal of DISC would result in a loss of jobs and
On the other hand the drastic changes in economic circumstances
have prompted some individuals to call for the elimination of DISC.
They take the position that DISC has not been particularly successful
in stimulating exports and that the international economic setting is
substantially different from what it was at the time the DISC was
adopted. Consequently, they argue that the usefulness of the DISC
provision is substantially less than it was at the time of its adoption.
Opponents of DISC suggest that the tax benefits from this treat-
ment are small relative to the volume of merchandise sold abroad and
thus are unlikely to have any major effect on sale. At the same time
they note that major decreases have taken place in prices due to flexible
exchange rates and suggest that. this is the major cause of export in-
creases rather than the DISC provisions.
They also question the economic rational of having an export incen-
tive during a period of flexible exchange rates. During a period of fixed
exchange rates (as when DISC was enacted) they suggest the incen-
tive could be used in part as a method for companies to reduce the
dollar price of their exports in the face of a fixed value of the dollar,
thus making our exports relatively more attractive. During a period
of flexible exchange rates, however, any increase in U.S. exports will
be reflected in greater demand for dollars and therefore a higher
exchange rate price for dollars in terms of other currencies. This
higher dollar value would make U.S. exports somewhat more expen-
sive, offsetting in part the initial increase in exports. Furthermore,
the higher dollar value means that foreign goods will be relatively
cheaper and consequently the United States would tend to import
Questions have also been raised as to whether the employment effects
of export stimulation are overemphasized. To the extent imports are
increased by the higher dollar value resulting from DISC, it is argued
U.S. corporations competing with imported goods are worse off and
may lose jobs. .

III III I'II1~lllll 1111111lltlllltll
31 3 1262 07125 7470

House Bill
The House bill eliminated from DISC treatment products sold for
use as military equipment and also agricultural products not in
surplus in the United States.
For taxable years beginning after December 31, 1975, DISC benefits
receipts would be allowed only to the extent that the DISC's income
for the year exceeds 75 percent of its base period in receipts. From
1976 through 1980, the base period is to be average DISC receipts of
the corporation in the years 1972, 1973, and 1974. Beginning in 1981
this base period is to move one year forward each year. Companies
whose total DISC benefits are less than $100,000 per year are not to be
subject to the new base period method of computation, but instead
may calculate their DISC benefits as provided by present law.
Taxpayers for whom DISC benefits were repealed under the Tax
Reduction Act of 1975 are to continue to receive DISC benefits for
exports made pursuant to binding contracts written after the com-
pany's DISC was established but before March 18, 1975, but only if
the contracts have both fixed price and fixed quantity requirements.
This binding contract rule is to apply for 5 years from March 18,
1975. The provision in the Tax Reduction Act of 1975 providing that
DISC tax treatment is not to be available if the commodity involved
is a natural resource subject to the allowance of cost depletion is
changed to eliminate DISC benefits for those items subject to the
allowance of percentage depletion.
Finally, the House bill contains two provisions relating to quali-
fication and recapture of DISC income in those cases where export
products lose their eligibility for DISC treatment. First, a DISC
may continue to loan its accumulated DISC earnings as a qualified
producer loan if the loan would otherwise qualify under the rules that
were applicable before the DISC benefits were eliminated for the
goods which the DISC exported if the parent continues to export
those goods. Second, the recapture of accumulated DISC earnings (be-
cause of DISC disqualification) are to be spread out over a period
equal to two years for each year that the DISC was in existence (up
to a maximum of 10 years), instead of being one year (up to a maxi-
mum of 10 years) provided under present law. (See. 1101)