Description of provisions listed for further hearings by the Committee on Finance on July 20, 21, and 22, 1976

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Description of provisions listed for further hearings by the Committee on Finance on July 20, 21, and 22, 1976
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United States -- Congress. -- Joint Committee on Internal Revenue Taxation
United States -- Congress. -- Senate. -- Committee on Finance
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Table of Contents
    Front Cover
        Page i
        Page ii
    Table of Contents
        Page iii
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        Page v
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    I. Introduction
        Page 1
    II. Description of provisions
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Full Text
\,L,/-..,/ -;


F'


[COMMITTEE PRINT]

i7i7ul ci


DESCRIPTION OF PROVISIONS LISTED
FOR FURTHER HEARINGS BY THE


COMMITTEE


ON FINANCE ON


JULY 20, 21, AND 22, 1976



PREPARED FOR THE USE OF THE
COMMITTEE ON FINANCE
BY THE STAFF OF THE
JOINT COMMITTEE ON INTERNAL REVENUE
TAXATION


JULY 19, 1976


U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 1976


V^


5/


74-375


JCS-30-76


















TABLE OF CONTENTS

Page
I. Introduction --------------------------------------------1------
II. Description of Provisions----------------------------------------- 2
1. At-Risk Limitation for Limited Partners (see. 210 of the bill) __ 2
2. Refunds of Unutilized Investment Tax Credits (sec. 802 of the
bill) --------------------------------------------------- 4
3. Expiring Investment and Foreign Tax Credits (sec. 803 of the
bill) ----------------------------------------------
4. Investment Credit in the Case of Vess-els Constructed from
Capital Construction Funds (sec. 806 of the bill)---------
5. Foreign Trusts Having One or More U.S. Beneficiaries To Be
Taxed Currently to Grantor (sec. 1011 of the bill)--------- 7
6. Investment in U.S. Property by Controlled Foreign Corpora-
tions (sec. 1021 of the bill)------------------------------- 7
7. Exclusion from Subpart F of Certain Earnit'gs of Insurance
Companies (sec. 1023 of the bill)------------------------- 8
8. Shipping Profits of Foreign Corporatioins (sec. 1024 of the
bill) --------------------------------------------------10
9. Limitation on Definition of Tax Haven Iniotie for Agricultural
Products (sec. 1025 of the bill) ---------------------------- 11
10. Repeal of the Per-Country Foreign Tax Credit lAmitation (sec.
1031 of the bill)----------------------------------------- 12
11. Recapture of Foreign Losses (sec. 1032 of the bill)----------- 13
12. Transitional Carryback of Foreign Taxes on Oil and Gas
Extraction Income (sec. 1035 of the bill)------------------- 15
13. Transitional Rule for Recapture of Forigun Oil-Related Lsses
(sec. 1035 of the bill)------------------------------------ 16
14. Definition of Foreign Oil-Related Income (sec. 1035 of the
bill) --------------------------------------------------16
15. Taxation of Foreign Oil-Extraction Income of Individiiual- (sec.
1035 of the bill)---------------------------------------- 18
16. Creditable Taxes on Oil Paymnents Where No Economic Inter-
est Exists (sec. 1035 of the bill) --------------------------- 19
17. Foreign Tax Credits Arising Through Oil and Gas Production
Sharing Contracts (sec. 1035 of the bill) ------------------- 20
18. Source of Underwriting Income (sec. 1036 of the bill)-------- 21
19. Third-tier Foreign Tax Credit Under Subpart F (se.. 1037 of
the bill)---------------------------------------------- 22
20. Bank Deposits in the United States of Nonresident Aliens and
Foreign Corporations (sec. 1041 of the bill) ---------------- 23
21. Sales or Exchanges Giving Rise to Dividends (sec. 1042 of the
bill) --------------------------------------------------23
22. Contiguous Country Branches of Domestic Life Insurance Com-
panies (sec. 1043 of the bill)------------------------------ 24
23. Transitional Rule for Bond, Etc., Losses of Foreign Banks (sec.
1044 of the bill)---------------------------------------- 27
24. Western Hemisphere Trade Co rporations (sec. 1052 of the
bill) -------------------------------------------------- 28
25. Treatment of Certain Individuals Employed in Fishing As Self-
Employed Individuals (sec. 1207 of the bill)--------------- 28
26. Tax Treatment of Certain 1972 Dis.aster Loans (sec. 1303 of the
bill) -------------------------------------------------- 29
27. Tax Treatment of Certain Debts Owved by Political Parties to
Accrual Basis Taxpayers (sec. 1304 of the bill) ------------- 31
28. Prepublication Expenses (sec. 1305 of the bill)--------------- 32


(Ill)









Page
29. Treatment of Face Amount Certificates (sec. 1307 of the bill)_ 34
30. Income from Lease of Intangible Property as Personal Holding
Company Income (sec. 1308 of the bill)-------------------- 36
31. Excise Tax on Parts for Light-Duty Trucks and Buses (sec.
1310 of the bill)---------------------------------------- 37
32. Certain Franchise Transfers (sec. 1311 of the bill)------------ 38
33. Clarification of an Employer's Duty to Keep Records and to
Report Tips (sec. 1312 of the bill) ------------------------- 40
34. Qualification of Fishing Organizations as Tax-Exempt Agricul-
tural Organizations (sec. 1314 of the bill) -------------------- 41
35. Limitation on Percentage Depletion for Oil and Gas Wells (sec.
1317 of the bill)------------------------------------- 41
36. Simultaneous Liquidation of Parent and Subsidiary Corpora-
tions (sec. 1320 of the bill)------------------------------- 44
37. Prohibition of State-Local Taxation of Vessels Using Inland
Waterways (sec. 1321 of the bill)------------------------- 45
38. Contributions to Capital of Regulated Public Utilities in Aid
of Construction (sec. 1322 of the bill)--------------------- 46
39. Prohibition of Discriminatory State Taxes on 'Generation of
Electricity (sec. 1323 of the bill)------------------------- 47
40. Tax-Exempl)t Annuity Contract.s in Closed-End Mutual Funds
(sec. 1.-)5 of the bill)------------------------------------ 48
41. Pension Fund Investments in Segregated Asset Accounts of
Life Insurance Companies (sec. 1506 of the bill)---------- 49
42. Extension of Study of Salary Reduction and Cash or Deferred
Profit-Sharing Plans (sec. 1507 of the bill)---------------- 50
43. Consolidated Returns for Life and Mutual Insurance Com-
panies (sec. 1508 of the bill)---------------------------- 51
44. Modifications in Investment Credit. for Railroads (sec. 1701 of
the bill)----------------------------------------------- 52
45. Amortization of Railroad Assets (sec. 1701 and 1702 of the
bill) --------------------------------------------------- 53
46. Residential Insulation Credit (sec. 2001 of the bill)----------. 55-
47. Residential Heat Pump Credit (sec. 2002 of the bill)---------- 56
48. Investment Credits Relating to Energy Conservation and Pro-
duction (sec. 2003 of the bill)---------------------------- 57
49. Deduction for Production and Intangible Drilling Costs of Geo-
thermal Resources (sec. 2004 of the bill) ----------------- 63
50. Recycling Tax Credit (sec. 2006 of the bill)------------------ 66
51. Repeal of Manufacturers Excise Tax on Buses and Bus Parts
(sec. 2007 of the bill)----------------- ---------------67
52. Exemption From the Retailers Exise Tax on Special Motor
Fuels for Certain Nonhighway Use (sec. 2009 of the bill) --. 69
53. Oil Swaps (sec. 2010 of the bill)---------------------------- 69
54. Modification of Transitional Rule for Sales of Leased Property
by Private Foundations (sec. 2101 of the bill)--------------- 70
55. Extension of Time To Conform Charitable Remainder Trusts
for Estate Tax Purposes (sec. 2104 of the bill)--------------- 72
56. Income From Fairs. Expositions, and Trade Shows (sec. 2106
of the bill) ----------------------------------------- 74
57. Generation-Skipping Transfers (sec. 2202 of the bill)-------- 75
58. Gift Tax Treatment of Certain Annuities (sec. 2203 of the bill)- 78
59. Outdoor Advertising Displays (sec. 2301 of the bill)---------- 79
60. Interest on Certain Governmental Obligations for Hospital
Construction (sec. 2308 of the bill)-------------------- 80
61. Group Legal Services Plans (sec. 2309 of the bill)----.------- 81
62. Exchange Funds (sec. 2310 of the bill)------------------ 83
63. Special Credit for Wind-Related Energy Equipment (sec. 2505
of the bill)-------------------------------------------- 86
64. Income Earned Abroad by U.S. Citizens Living or Residing
Abroad (sec. 2503 of the bill) ----------------------------- 87
65. Level Premium Annuity Contracts Held by H.R. 10 Plans (sec.
2508 of the bill) ----------------------------------- 88






V


66. Unrelated Business Income of Tax-Exempt Hospitals (sie. 2509 Page
of the bill)------------------------------------------- 89
67. Hospital Laundry Facilities (sec. 2509 of the bill) ------------ 90
68. Certain Charitable Contributions of Inventory (sec. 2511 of the
bill) -------------------------------------------------- 90
69. Tax Liens, Eretc., Not To Constitute "Acquisition Indebtedn(.i-:<"
(sec. 2513 of the bill)------------------------------------ 92
70. Extension of Private Foundation Transition Rule for Sale of
Business Holdings (sec. 2514 of the bill)------------------ 94
71. Private Operating Foundations; Imputed iiterci-t (sec. 2515
of the bill)-------------------------------------------- 95
72. At-Risk Limitation for Equipment Leasing------------------ 96
73. Corporations in Possessions of the United States (.-vc. 2519
of the bill)-------------------------------------------- 97


















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I. INTRODUCTION


The provisions described in this pamphlet are those on which the
Committee on Finance will hold thlce consecutive mornings of public
hea rings beginning on Tuesday, July 20, 1976.
In announcing these hearings Senator Long noted that concern has
been expressed as to whether certain provisions approved by the com-
mittee for incorporation in H.R. 10612, the Tax Reform Act, were the
subject of sufficient hearings and discussion. Although the committee
held four weeks of public hearings on the tax bill, but that the Com-
mittee. in the interest of expediting the bill for floor consideration,
may not have examined some of the provisions as extensively as other-
wise might have been the case. As a result, these hearings are intended
to provide a more complete record on these provisions.
The amendments listed for consideration in these hearings include
in some cases provisions on which testimony has already been taken by
the Finance Committee in public sessions. The list also includes provi-
sions contained in the House-passed bill on which Finance Committee
modification was quite minor, provisions which have previously been
approved by the House Ways and Means Committee, and other provi-
sions which have passed the House in separate legislation.
In addition, the hearings include amendments called to the attention
of the Committee by members during the extended markup session af-
ter the hearings. Senator Long pointed out that toward the end of the
lengthy markup, the Finance Committee was under heavy pressure
to report the tax bill to the Senate at the earliest possible time. He
stated at the time that certain amendments not included in this bill, but
recommended by the Committee, had been approved without the bene-
fit of extensive hearings and study. He requested additional informna-
tion, both for and against these amendments at the time, with the hope
that the Committee would benefit from the information subsequently
received. These hearings will provide an appropriate forum for the
submission of such information.
Finally, the list includes a floor amendment imposing an at-risk lim-
itation for limited partners, a provision not previously considered at
Committee sessions.
This pamphlet was prepared by the staff to provide background in-
formation with respect to the provisions listed for consideration dur-
ing the public hearings. The pamphlet describes each provision, in-
dicating in each case the present law treatment, the issue involved, an
explanation of what the provision will do (including the effective date
of the provision), and the revenue effect, of the provision (if any).
It has also been requested that the sponsors of the provisions be
listed together with any persons that also would be indicated as those
who will benefit from the provisions. To the extent this information
is available to the staff, it is indicated in this pamphlet in the general
explanation of each provision. However, since the markup session was
(1)







not a recorded session, no official record was kept of those who pro-
posed the amendments. As a result, the staff has listed those. it believes
proposed the amendments where this information is available. As to
those who benefit from the provisions, in many cases it is impossible
to have any full listing of all taxpayers who do or may benefit from
a particular provision. However, the staff has listed those it believes
are interested in particular provisions where this has been called to
the staff's attention. Other beneficiaries of provisions may have
come to the attention of the Senators' offices.

III. DESCRIPTION OF BILLS
1. At-Risk Limitation for Limited Partners (sec. 210 of the bill-
floor amendment-Congressional Record, June 22, 1976,
pp. S10106-S10110)
Present lazL
Limited partnerships, which, upon meeting certain requirements.
are subject to both the general partnership provisions and certain
provisions of the income tax regulations having particular application
to limited partnerships.
In general, a partnership is not considered a separate entity for tax
purposes; rather, the individual partners are taxed currently on their
share of the partnership gains and can deduct partnership losses to
the extentof the basis of their partnership interest.
A limited partner is a passive investor who is not personally liable
for any more than his equity contribution to the partnership (plus
his agreed future contributions).
Commonly, the equity contributions of limited partners do not
adequately capitalize the operations of a limited partnership. The
additional capital frequently is obtained by borrowing, using part-
nership property as security, without the limited partnership or its
partners incurring any personal liability with respect to that
borrowing.
A limited partner may deduct from his personal income all the
deductible items of the partnership which are allocated to him under
the partnership agreement, but not more than the amount of his basis
for his interest in the partnership, which is reduced by the amount
of the deductions as they are taken.
In general, at the inception of the partnership, a limited partner's
basis for his interest equals the sum of his capital contribution plus
his share, if any, of partnership liabilities. Under the Treasury's
income tax regulations ( 1.752-1 (e)), the general rule is that "a lim-
ited partner's share of partnership liabilities shall not exceed the
difference between his actual contribution credited to him by the
partnership and the total contribution which he is obligated to make
under the limited partnership agreement." Thus,, for example, if a
limited partner who is obligated 1 under the partnership agreement
to contribute $10,000 to the partnership makes an initial contribution
of $1,000, his share of partnership liabilities would be limited under
this rule to $9,000 ($10,000-$1,000).
This rego-ulation further provides, however, that "where none of the
partners have any personal liability with respect to partnership lia-
SThis assumes that the obligation of the limited partner to make the contribution is
unconditional. It is not clear whether this provision applies to conditional or contingent
ohigations of the limited partner to make a contribution.








ability (as in the case of a mortgage on real estate acquired by the part-
nership without the assumption by the partnership or any of the
partners of any liability on the mortgage), then all partners, including
limited partners, shall be considered as sharing such liability under
section 752(c) in the sailne proportion as they share the profits."2
Through the use of this rule, a limited partner may obtain a sub-
stantial increase in his basis, and, thus, in the amount of losses lihe
may deduct.3
In 1972, the Internal Revenue Service issued two rulings involving
nonrecourse loans. While both rulings dealt with and have particular
application to limited partnerships engaged in oil and gas exploration,
they are susceptible to a much broader application. In Rev. Rul.
72-135, 1972-1 C.B. 200, the Service ruled that a nonrecourse loan
from the general partner to a limited partner, or from the general
partner to the partnership, would constitute a contribution to the
capital of the partnership by the general partner, and not a loan,
thereby precluding an increase in the basis of the limited partner's
partnership interest with respect to any portion of such a loan. In
Rev. Rul. 72-350, 1972-2 C.B. 394, the Service ruled that a non-
recourse loan by a nonpartner to the limited partnership, which was
secured by highly speculative and relatively low value property of the
partnership, and which was convertible into a 25 percent interest in
the partnership's profits, did not constitute a bona fide debt, but was,
in reality, equity capital placed at the risk of the partnership's busi-
ness. This, too, would preclude increases in the bases of the limited
partner's interests.
IssUle
The issue is whether a limited partner should be allowed to in-
crease the amount of the basis in his partnership interest by a portion
of partnership indebtedness so as to allow him to deduct an amount
of partnership losses which exceeds the amount of inmeshment he
actually has and will have at risk in the partnership.
Explanation of provision
This provision was a Senate floor amendment sponsored by Senators
Haskell, Kennedy, Hollings, and Hathaway. It eliminates the special
rule of the regulations ( 1.752-1 (e)) for allocation of nonrecourse
liabilities to limited partners. Instead, it applies the general rule
of regulations to both recourse and nonrecourse obligations.
This provision therefore restricts the amount of partnership lia-
bilities which may be included in a limited partner's basis in his
partnership interest to an amount equal to any further contributions
(over and above any actual contributions) which the limited partner
is obligated to make pursuant to the partnership agreement. The effect
of this provision is to limit deductions which may be passed through
to a limited partner to the amount of investment which he actually
has and will have rat risk in the partnership.
2 This rule has been justified as an adaptation to the limited partnership situation of a
principle set forth by the United States Supreme Court in Crane v. Commissioner, 331
U.S. 1 (1947).
3 For example, if a limited partner initially pays $1.000 and is unconditionally obligated
to make further contributions totalling $9,000 for a 5 percent interest in the capital and
profits and losses of a limited partnership which obtains a nonrecourse loan of $500,000.
the limited partner's basis in his interest would be $26,000 ($1,000 plus 5% of $500.000).
Thus, as a result of this rule, the limited partner may be able to deduct an amount far
excppdina the amount of investment that he actually has and will have at risk in the
partnership.







The provision applies to limited partnerships formed after June 30,
1976, except in the case of limited partnerships involved in the con-
struction or rehabilitation of low income housing (within the mean-
ing of section 1039(b)), where it will apply to limited partnerships
formed after December 31, 1981.
This provision would have wide application to many diverse types of
limited partnerships. Probably its most important impact would be
in the case of limited partnerships concerned with real estate.
Revenue effect
It is estimated that this provision will result in an increase of $5
million in budget receipts in fiscal year 1977, $6 million in fiscal year
1978 and $90 million in fiscal year 1981.
2. Refunds of Unutilized Investment Tax Credits (sec. 802 of the
bill)
Present law
Under present law, the investment tax credit generally cannot in
any taxable year exceed the first $25,000 of tax liability plus 50 per-
cent of the tax liability in excess of the $25,000. Investment tax credits
which cannot be used because of this limitation may be carried back:
3 taxable years and used in those years to the extent possible within
the limitation and then carried forward 7 taxable years and used in
those years within the limitation. (In the case of public utilities, the
50-percent limitation increases to 100 percent in 1975 and 1976, 90
percent in 1977, 80 percent in 1978, 70 percent in 1979, 60 percent in
1980, and 50 percent thereafter.) Any remaining investment credit
under present law cannot be used.
Issue
The issue is whether investment tax credits that will expire in tlhe
future because of insufficient tax liability to offset them should be
refunded or whether the carryforward period should be extended.
Explanation of provision
This provision was proposed by Senator Long. It allows investment
tax credits which are earned with respect to property which becomes
eligible for the investment tax credit on or after January 1, 1976, and
which cannot be entirely used during the 3-year carryback and 7-year
carryforward period to be refunded at the expiration of the carry-
forward period. Thus, taxpayers who are unable to use investment tax
credit resulting from investments in 1976, and over the next seven years
(as well as the previous 3 years) will be entitled to a refund of such
credits beginning in 1984.
This provision generally would be beneficial to low-profit or loss
companies. Some have suggested that this provision would be par-
ticularly beneficial to airlines, railroads and utilities. However, this
would appear to be true only in the case of those with low profits or
losses currently and then only if they remain in that status until 1984.
Revenue effect
It is estimated that this provision will not affect revenues until
1984. In that year, it estimated that this provision will result in a
reduction of revenues of $300 to $500 million.







3. Expiring Investment and Foreign Tax Credits (sec. 803 of the
bill)
Present law
Under present law the investment tax credit for any year generally
cannot exceed the first $25,000 of tax liability plus 50 percent of the
tax liability in excess of $25,000. If the amount of investment tax
credit for any year exceeds the applicable limitation based on the
amount of tax liability for that year, the excess is generally an invest-
ment credit carryback to each of the three preceding taxable years
and an investment credit carryover to each of the seven following tax-
able years and, subject to certain limitations, is added to the amount
allowable as a credit for those years (sec. 46(b) ).1 If any portion of a
credit remains after application to the carryback and carryover pe-
riods, the unused portion expires and cannot be used subsequently by
the taxpayer.
Present law provides, subject to certain limitations, for a two-year
carryback and five-year carryforward of unutilized foreign tax credits
(sec. 904). As in the case of the investment tax credit, any portion of
a credit which remains unused after the application of the two-year
carryback and five-year carryforward expires and cannot be used
subsequently by the taxpayer.
Issue
During 1970-1971 and 1974-1975 the economy suffered two serious
recessions. Nonetheless, in order to remain competitive domestically
and internationally, many firms have continued to invest in new plant
and equipment in the U.S. and have maintained their overseas business
operations. However, where domestic operations have subsequently
worsened and created net operating losses, these losses have often
eliminated domestic income in earlier years and resulted in carry-
forwards of previously absorbed tax credits.
The issue is whether, in order to mitigate these problems, an addi-
tional carryforward period should be provided for the investment and
foreign tax credits which would otherwise expire in 1976 (e.g. invest-
ment credits earned before 1970 and foreign tax credits earned in
1971).
Explanation of provision
This provision was proposed by Senator Long and subsequently
modified by Senator Hartke. It establishes that investment and foreign
tax credits that may be carried over to 1976, but which would other-
wise expire after that year may be carried over for two additional
years, to 1977 and 1978. This additional carryforward does not apply
to credits that might expire in 1977 or 1978, but only to credits which
would expire in 1976. Similarly, the additional carryforward in the
case of the foreign tax credit does not apply to credits expiring in
1977 or 1978.
In addition, any foreign tax credit carryovers which otherwise
would expire in 1976 but which have been extended through 1978 are
to be used first in 1977 and 1978 against any foreign income received
in those years (i.e., before any credits arising currently in those years).
1 However, certain pre-1971 investment credits are allowed a 10-year carryover.







This provision will tend to benefit low profit or loss companies,
such as some airlines, utilities and railroads. It has been suggested that
this provision will benefit Chrysler Corporation. While representa-
tives of that company have indicated an interest in this provision, it
is not clear that in its present form this provision will benefit this
colnipany.
Revenue effects
It is estimated that the additional two year carrvforward of invest-
ment tax credit will result in a decrease in budget receipts of $14
million in fiscal year 1977 and $30 million in fiscal year 1978. It is
estimated that the re-ordering of foreign tax credit carryforwards
will result in a decrease in budget receipts by $2 million in fiscal year
1977, $3 million in fiscal year 1978, and $1 million in fiscal year 1981.
4. Investment Credit in the Case of Vessels Constructed from
Capital Construction Funds (sec. 806 of the bill)
Pie.sen.t law
Present law provides that income tax is not to be payable on certain
income from domestic shipping deposited in a capital construction
fund. However, when monies are withdrawn from this fund, they then
are generally taxable unless they are used for the construction of ships
to be used primarily in domestic trade.
To prevent a double allowance for these tax-deferred amounts,
present law provides that when these funds are used to finance ship
construction there is to be no tax cost. or basis, in the ship. This means
that no depreciation is permitted on the part of the investment in the
ship that is financed out of the capital construction fund.
Under present law, the amount of the investment., credit available
is also based on ten percent of the tax cost or basis of a qualifying
property (sec. 46(c)(1)(A) of the code). As a result, the Internal
Revenue Service has ruled that no investment credit is available to
the extent a vessel is built, purchased, or reconstructed with monies
withdrawn from the capital construction fund.
Issue
The issue is whether or not to provide the investment tax credit
for the full cost of constructing a qualified vessel under the Merchant
Marine Act of 1970, rather than for the tax basis of such vessel.
Explanation of pro vision
This provision was proposed by Senator Long. A similar provision
has previoulsly been reported favorably 1by the Senate Commnerce Com-
mittee and passed by the Senate. The provision requires that the
amount of a qualified investment for investment tax credit purposes
is not to be reduced because of a deposit in. or Qualified withdrawal
from, a capital construction fund established under section 21 of the
Merchant Marine Act of 1970 or because that provision requires a
reduction in basis of property acquired with monies from such a fund.
This provision should be of benefit to many members of the domestic
maritime industry.
Revenue effects
It is estimated that the amendment will result in a reduction of
$21 million in revenues in FY 1977, $23 million in FY 1978, and $45
million in FY 1981.








5. Foreign Trusts Having One or More U.S. Beneficiaries To Be
Taxed Currently to Grantor (sec. 1011 of the bill)
Present law and committee amendment
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 sec.
7701 (a) (31)) to be a foreign trust.
The committee amendment contains a new grantor trust provision
under which, in general, any U.S. person transferring property to a
foreign trust which has a U.S. beneficiary is treated as owner of the
portion of the trust attributable to the property transferred by the
U.S. person. Any U.S. person treated under this provision as owner of
a portion of a trust is taxed on the income of that portion of the trust
in the same manner as an owner of a trust is taxed under the existing
grantor trust rules (part I of subchapter J of the Internal Revenue
Code).
Issue
The House provision applied to transfers of property to foreign
trusts after May 21, 1974 (the date of the initial Ways and Means
Committee decision). However, no news report of the committee de-
cision was made until May 29, 1974. Thus, taxpayers who did not have
access to individuals physically present at the Ways and Means Com-
mittee markup could not know of the committee decision. The issue
is whether the date for applying the new grantor trust rules should
be made May 29,1974.
Explanation of provision
This provision was suggested by the staff as an alternative to the
date in the House bill. The provision delays the date for which the
new grantor trust rules apply from transfers of property to foreign
trusts made after May 21, 1974, to transfers made after May 29, 1974.
It has been reported that this provision will benefit trusts established
by James L. Walker, Stanley L. Timmins, William B. Rapien, and
Russell A. Kendall.
6. Investment in U.S. Property by Controlled Foreign Corpora-
tions (sec. 1021 of the bill)
Present law and committee amendment
Present law treats an investment in U.S. property by a controlled
foreign corporation as a taxable distribution to the U.S. shareholders
of the corporation. Present law is very broad as to the types of property
which are classified as U.S. property for purposes of this rule.
The committee amendment narrows the types of investments that
are treated as U.S. property and thus result in dividend taxation to
the U.S. shareholders if an investment is made in the property by the
controlled foreign corporation. Under the committee amendment, the
term "U.S. property" does not include stock or debt of a domestic







corporation if the U.S. shareholders of the controlled foreign corpora-
tion are considered as owning less than 25 percent'of the voting power
of the domestic corporation. Also, movable drillings rigs are not con-
sidered as U.S. property when used on the continental shelf. The effec-
tive date of the committee amen(lment, is generally for taxable years
beginning after December 31,1975.
a. Investments on the continental shelf
ITsue
The issue is whether investments in assets located on the continental
shelf or in stock or obligations of a U.S. corporation substantially
all of the assets of which consist of property located on the continental
shelf should be treated as U.S. property for the period prior to Janu-
ary 1, 1977.
Ea ipla n t ion, of proviso ion
This provision was in the House bill but was modified by the Sen-
ate Finance Committee so that it has no prospective application. The
provision permits taxpayers to elect to exclude certain investments
from the definition of United States property. The election applies
retroactively to all taxable years beginning before 1977 to which
the provision defining the United States to include its continental
shelf (sec. 638) applies. This election only applies to property sit-
uated on, or used exclusively in connection with. the continental
shelf or investments in stock or obligations of a domestic corpora-
tion, substantially all of the assets of which consist of such prop-
erty. This provision will be of benefit to the Superior Oil Company.
b. Investments made after May 21,1974

The issue is whether controlled foreign corporations which have
made investments in property which is excluded from the definition of
U.S. property under the committee amendment should be permitted to
elect to apply the new definition of U.S. property to investments made
after May 21,1974 (the date of the initial Ways and Means Committee
decision).
Explanation of pro r;sion
This provision was proposed by Senator Long. Taxpayers may
elect to have investments in stock or obligations of a domestic cor-
poration excluded from the definition of U.S. property if there is less
than a 25-percent voting interest in the corporation and the investment
was made after May 21, 1974. This provision will be of benefit to
Pyramid Ventures Inc.
7. Exclusion from Subpart F of Certain Earnings of Insurance
Companies (sec. 1023 of the bill)
Present law
.One of the categories of foreign tax haven income subject to cur-
rent taxation under present law is foreign personal holding conm-
pany income (sec. 954(c)). This item of foreign tax haven income
consists of passive investment income such as dividends, interest.
rents and royalties. Present law provides an exception for income of







a foreign insurance company from its investment of unearned pre-
miniums or reserves which are ordinary and necessary for the proper
conduct of its business.
Issue
In order to write insurance and accept reinsurance premiums, for-
eign insurance companies may be required by the laws of various
jurisdictions in which they operate to meet various solvency require-
ments in addition to specified capital and legal reserve requirements.
Many jurisdictions also employ an internal rule-of-thumb as to what
the ratio of surplus to earned premiums should be. In the United
States, the National Association of Insurance Commissioners employs
a ratio of 1 to 3 (surplus to earned premiums) as the guideline by
which State regulatory agencies can measure the adequate solvency
of companies insuring casualty risks. Where the foreign jurisdiction
does not impose requirements as severe as those required in the United
States, a foreign insurance company participating in a reinsurance
pool composed principally of companies doing business in the United
States must, for all practical purposes, maintain this ratio to satisfy
the State insurance authorities involved.
These various requirements mean that an insurance company must
keep a reserve of assets in relatively short-term passive investments.
As a result the question arises as to whether the income from these
investments should be treated as tax haven income.
Explanation of provision
This provision was in the House bill and was not changed by the
Senate Finance Committee. The provision adds a new exception to the
definition of foreign personal holding company income (sec. 954(c)
(3) (C)). Under the exception, foreign personal holding company in-
come does not include dividends, interest, and gains from the sale or
exchange of stock or securities derived from investments made by an
insurance company of an amount of assets equal to one-third of its
premiums earned (as defined under sec. 832 (b) (4)) during the taxable
year on insurance contracts (other than for life insurance and annuity
benefits under life insurance and annuity contracts, to which sec. 801
pertains).
The exception only applies to passive income received from a person
other than a related person (as defined in sec. 954(d) (3)). Also, the
exception only applies with respect to premiums which are not directly
or indirectly attributable to the insurance or reinsurance of related
persons.
The provision applies to taxable years of foreign corporations
beginning after December 31, 1975, and to taxable years of U.S. share-
holders within which or with which the taxable years of the foreign
corporations end.
This provision applies to the American International Group, Inc.
Revcenuc effect
It is estimated that this provision will result in a decrease in
budget receipts of $11 million in fiscal year 1977 and of $10 million
per year thereafter.





10

8. Shipping Profits of Foreign Corporations (sec. 1024 of the
bill)
Present law
One of the categories of foreign base company tax haven income sub-
ject to current taxation under the subpart F provisions of the Code is
income derived from, or in connection with, the use of an aircraft or
vessel in foreign commerce, except to the extent that the profits are
reinvested in shipping assets.
a. Country of incorporation and registration
Issue
In general, foreign tax haven income includes income earned by a
corporation outside the country of incorporation. In the case of ship-
ping income, however, no distinction is made under present law be-
tween cases where a corporation derives its shipping income in the
same country where it is registered and incorporated and flag of
convenience corporations which operate all over the world (other than
the country of incorporation.) The issue is whether shipping activ-
ities should be categorized as a base company activity when the cor-
poration involved carries on its activities entirely i1' the country in
which it is organized.
Explanation of provision
This provision was added in the House bill and was not changed by
the Senate Finance Committee. It establishes an exception to the for-
eign tax haven rules for shipping income derived from the operation
of a vessel or airplane between two points in the country in which the
vessel or airplane is registered and the corporation owning the vessel
or airplane is incorporated.
This provision affects the Hall Corporation Shipping Ltd.
b. Drilling rig service companies
188 U e
The issue is whether an exception to the tax haven provisions should
be added in the case of a supply shipping operation between a point
on shore and nearby offshore points.
Explanation of provision
This provision was proposed by Senator Bentsen. It provides an
exception from the foreign tax haven rules for shipping income derived
from the transportation of men and supplies from a point in a foreign
country to a point (such as an oil drilling rig) located on the continen-
tal shelf of that country or on the continental shelf adjacent to the
continental shelf of that country.
This provision will affect all companies in the business of servicing
oil drilling rigs. Interest has been expressed in this provision by the
Jackson Maritime Company and the Tidewater Marine Service, Inc.
c. Short-term charter income
Issue
The issue is whether an exception to the tax haven provisions should
be applied in the case of a foreign corporation if neither the corpora-
tion nor any related person is involved in the shipping business except
by deriving short-term charter income.








Explanation of provision
This provision was proposed by Senator Long. It provides an excep-
tion from the foreign tax haven rules for shipping income derived by
a corporation from the short-term charter of vessels if that corporation
or any related person does not own any ships or shipping facilities and
does not manufacture, grow or extract goods shipped on vessels used
by that corporation.
The Southern Scrap Materials Company, Ltd. expressed interest in
this provision but since it owns ship facilities, this provision will
have no application to that company.
d. Investments in qualified shipping assets
Issue
When shipping assets are acquired by using funds obtained by un-
secured loans, present law is unclear as to what shipping profits are
considered as reinvested in shipping assets and thus entitle a con-
trolled foreign corporation to an exclusion from the subpart F
provisions.
Explanation of provision
This provision was in the lHouse bill and not changed by the Senate
Finance Committee. It clarifies the method of determining the amount
of a controlled foreign corporation's qualified investments in .-llipping
assets (sec. 955 (b) (4)). Under the provision that a liability evidenced
by an open account or a liability secured only by the general credit of
the corporation is to be taken into account in determining the amniount
of the corporation's qualified investments in shipping assets, to the
extent that such a liability constitutes a claim against the corporation's
shipping assets. As a result, payments made by the corporation in dis-
charge of an unsecured liability are treated under the amendment as
increasing qualified investments in shipping assets, to the extent that
the unsecured liability constitutes a claim against the corporation's
shipping assets.
This provision has application to Hall Corporation Shipping Ltd.
9. Limitation on Definition of Tax Haven Income for Agricul-
tural Products (sec. 1025 of the bill)
Present law
One of the categories of foreign tax haven income subject to current
taxation under the subpart F provisions of the Code is base company
sales income. The Tax Reduction Act of 1975 contained an amendment
which provides that base company sales income does not include the
sale of agricultural commodities which are not grown in the United
States in commercially marketable quantities.
Issue
Questions have been raised as to whether this exclusion applies to
all agricultural products which are of a different grade or variety from
the same product grown in the United States. The Treasury has taken
the position that the exception in present law is very narrow. In addi-
tion it is questioned whether all foreign grown agricultural goods
should be excluded from the definition of tax haven income.
Explanation of provision
The basic provision was in the House bill. The modification made
was suggested by the Treasury Department staff. The provision ex-
74-375-76-----2







eludes, for purpose.- of the tax haven foreign base company sales rules
of subpart F, agricultural commodities grown or produced outside the
United States if sold for use, consumption, or disposition outside the
United States.
This provision applies to taxable years of foreign corporations be-
ginnings after December 31, 1975, and to taxable years of U.S. share-
holders within which or with which the taxable years of the foreign
corporation.
This provision will affect most of the international grain corpora-
tions. Cargill, Inc., has been mentioned specifically as one bene-
ficiary.
Revenzue effect
It is estimated that this provision will reduce budget receipts by $17
million in fiscal year 1977, $15 million in fiscal year 1978, and $15 mil-
lion in fiscal year 1981.
10. Repeal of the Per-Country Foreign Tax Credit Limitation
(sec. 1031 of the bill)
Preez nt iaw and committee amendment
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, the amount of foreign tax credits which a tax-
payer can apply against his U.S. tax liability on his worldwide in-
come is limited to his U.S. tax liability multiplied by a fraction the
numerator of which is taxable income from sources outside the United
States (after taking all relevant deductions) and the denominator of
which is his worldwide taxable income.
The alternative limitation is the per-country limitation. Under
this limitation the same calculation made under the overall limitation
is made on a country-by-country basis. The allowable credits from any
single foreign country cannot exceed an amount equal to U.S. tax on
worldwide income multiplied by a fraction the numerator of which
is the taxpayer's taxable income from that country and the denomina-
tor of which is worldwide taxable income.
The provision repeals the per-country limitation. Taxpayers will
be required to compute the limitation of the amount of foreign tax
which can be used to reduce U.S. tax under the overall limitation.
The effect of this provision is that losses from any foreign country
will reduce income from other foreign countries for purposes of
calculating the foreign tax credit limitation, and thus will reduce the
amount of foreign taxes which can be used from those countries as a
credit against U.S. tax. Foreign losses will reduce U.S. tax on U.S.
income only in cases where foreign losses exceed income from all for-
eign countries for the taxable year.
Issue
The issue is whether transitional rules for the repeal of the per-
country limitation should be provided in certain limited situations
where substantial investments of capital have been made under the
assumption that the foreign tax credit could be computed under the
per-country limitation.







Explanation of provision
The basic provision eliminating the per-country limitation was in
the House bill. In addition, the House bill contained two transitional
rules, one relating to mining and one relating to business in Puerto
Rico and possessions. The Finance Committee made no change in the
modification creating to mining. It tightened up the provision relating
to Puerto Rico and the possessions.
Certain existing mining ventures were begun with substantial inveZt-
ments of capital under the assumption that the foreign tax credit could
be computed under t'he per-country limitation. The provision permits
a limited transitional rule under which the per-country limitation may
be used for years beginning before 1979 for domestic corporations
(whether or not included in a consolidated return) which have, as
of October 1, 1975, satisfied four conditions. The four conditions are
that the corporation had as of October 1, 1975: (1) been engaged in
the active conduct of the mining of hard minerals (of a character for
which a percentage depletion deduction is allowable (under sec. 613))
outside the United States or its possessions for less than 5 years; (2)
had losses from the mining activity in at least 2 of the 5 years; (3)
derived 80 percent of its gross receipts since the date of its incorpora-
tion from the sale of the minerals that it mined, and (4) made commit-
ments for substantial expansion of its mining activities.
A similar problem was presented with respect to certain ventures
begun in Puerto Rico or other possessions and the provision applies
the special transition period developed for mining ventures to existing
ventu-es in Puerto Rico or other possessions. The House bill retained
the per-country limitation in the case of income and losses from Puerto
Rico and other possessions. Losses sustained on a per-country basis
under this provision are subject to future recapture on a per-country
basis.
The transitional rule relating to mining is believed to benefit the
Freeport Minerals Company. Other mining corporations may also
benefit. The provision relating to Puerto Rico and the possessions
applies to PPG Industries, Inc.
Reve.nue effect
It is estimated that the transitional rules with respect to mining
will reduce budget receipts by $12 million in fiscal year 1977, $10
million in fiscal year 1978, and $5 million in fiscal year 1979. It is
estimated that transitional rule with respect to Puerto Rico and the
possessions will reduce budget receipts by $6 million in fiscal year
1977, $5 million in fiscal year 1978, and $3 million in fiscal year 1979.
11. Recapture of Foreign Losses (sec. 1032 of the bill)
Present law and committee amendment
Present law permits taxpayers subject to U.S. tax on foreign source
income to take a foreign tax credit for the amount of foreign taxes
paid on income from sources outside of the United States. However,
there are certain situations in which the present foreign tax credit
system may indirectly result not only in a reduction of U.S. taxes on
foreign source income previously subject to foreign tax, but also in a
reduction of U.S. tax on U.S. source income not subject to foreign tax.
The provision provides for the repeal of the per-country limita-







tion, which will prevent a taxpayer who has foreign losses from
reducing his U.S. tax on U.S. income if the taxpayer also has
foreign income equal to or greater than the amount of losses.
However, in a case where an overall foreign loss exceeds foreign
income in a given year, the excess of the losses can still reduce U.S.
tax on domestic source income. In this case, if the taxpayer later
receives income from abroad on which he obtained a foreign tax credit.
the taxpayer receives the tax benefit of having reduced his U.S. income
for the loss year while not paying a U.S. tax for the later profitable
year. To reduce the advantage to these taxpayers, the committee has
included a provision which requires that in cases where a loss from
foreign operations reduces U.S. tax on U.S. source income, the tax
benefit derived from the deduction of these losses should, in effect, be
recaptured by the United States when the company subsequently
derives income from abroad.
In general, the recapture is accomplished by treating a portion of
foreign income which is subsequently derived as income from domestic
sources. The amount of the foreign income which is to be treated as
income from domestic sources in a subsequent year is limited to the
lesser of the amount of the loss (to the extent that the loss has not been
recaptured in prior taxable years) or 50 percent of the foreign taxable
income for that year, or such larger percent as the taxpayer may
choose. Thus, in any taxable year the amount subject to recapture
is not to exceed 50 percent of the taxpayer's foreign income (before
recharacterization) unless the taxpayer chooses to have a greater
percentage of his foreign income so recharacterized. For purposes of
the recapture provision, a "foreign loss" does not include foreign
expropriation losses.
Issue
The issue is whether the loss recapture provisions should apply to
losses sustained for tax purposes in taxable years beginning after the
December 31, 1975, effective date in certain situations where the in-
vestments had become worthless prior to that date or their value was
greatly reduced because of losses incurred prior to that date.
Explanation of proviswn
This provision was proposed by Senator Packwood. The loss re-
capture provisions do not apply in the case of a loss from the disposi-
tion of a bond, note, or other evidence indebtedness issued before
May 14, 1976, by a foreign government or instrumentality thereof for
property located in that country or stock or indebtedness of a corpora-
tion incorporated in such country. This provision is intended to pro-
vide relief where domestic corporations incur losses with respect to
foreign subsidiaries because they were forced, under the threat of
expropriation, to exchange their stock or assets for long-term debt
obligations of a foreign government. This provision applies to Boise
Cascade Corporation.
A second exception was proposed by Senator Talmadge. This excep-
tion is provided where an investment in the stock or indebtedness of a







corporation in which the taxpayer owned at least 10 percent of the
voting stock is substantially worthless prior to the effective date but
where the loss is not sustained for tax purposes until after the effec-
tive date if the taxpayer terminates its investment in the loss cor-
poration or corporations by liquidating, selling or otherwise disposing
its invest meant before January 1, 1977, and the loss corporation has
suffered an operating loss in three out of the last five taxable years
bo)egiining before 1976 and sustained an overall loss for those five
years. This provision applies to United Merchants and Manufactur-
ing, Inc.
Another provision was added by Senator Curtis. In some cases, a
corporation may want to continue an investment beyond 1976 in an
attempt to try to make the investment. profitable, although it may
ultimately fail in that endeavor. A third exception provides that if a
loss would qualify for the second exception to recapture but for the
fact that the investment is not terminated in 1976, there is to be no
recapture of the loss to the extent there was on December 31, 1975, a
deficit in earnings and profits, if the investment is terminated before
January 1, 1979. This provision applies to Xabisco, Inc.
12. Transitional Carryback of Foreign Taxes on Oil and Gas
Extraction Income (sec. 1035(a) of the bill)
P 'sei lf himf
Present law contains a limitation on the amount of foreign taxes
with respect to foreign oil and gas extraction income which are allow-
able as a credit. This limitation was phased in beginning in 1975. The
limitation is equal to 50.4 percent of the foreign oil and gas extraction
income in 1976 'and 50 percent of that income in 1977 and later years.
Fore.igr taxes in excess of the limitation are not allowable as a credit
in that year and cannot be carried forward or back to any other year.
Issue
The issue is whether during the phase-in period some ,--' ryforward
or carryback provision is appropriate to deal with situations where
timing differences between foreign tax systems and the U.S. tax system
can result in a taxpayer having no foreign tax credits in some years
in which the taxpayer has taxable income for U.S. tax purposes and
having excess foreign tax credits in other years in which the taxpayer
has little or no U.S. tax liability.
E.,pl;anation of pro-i, This provision is in the House bill and no change was made by
the Senate Finance Committee. The provision permits a carryback to
any taxable year ending in 1975, 1976, or 1977. The extraction taxes
which may be carried back may offset only extraction income in the
same country to which the extraction taxes were paid. The amount
which may be carried back to any taxable year is limited to the net
U.S. tax liability on the extraction income from that country for the
year after taking into account any other foreign tax credits.







This provision affects Natomas and various small oil companies with
operations in Indonesia.
Revenue effect
It is estimated that this provision will reduce corporate income tax
liability for the year 1976 by $5 million, for the years 1.977 and 1978,
$10 million, and for the year 1979, $5 million.
13. Transitional Rule for Recapture of Foreign Oil-Related Losses
(sec. 1035(b) of the bill)
Present law
Present law, as amended by the Tax Reduction Act of 1975, requires
that the foreign tax credit be computed under a separate overall limi-
tation for foreign oil-related income and that any foreign oil-related
losses for taxable years ending after December 31, 1975, be recaptured
in future years. The amount of losses to be recaptured in any year
is the lesser of all prior unrecaptured losses or 50 percent of foreign
oil-related income for the year.
Issue
The issue is whether any transitional rule should be provided for
taxpayers who made investments in 1975 and earlier years with the
anticipation that the losses arising in the early years of those invest-
ments (generally the first 3 to 5 years) would be allowed to reduce
U.S. tax on U.S. income without being subject to full recapture under
the provisions of present law.
Explanation of pirorision
This provision was proposed by Senator Curtis. The provision allows
a taxpayer to recapture certain foreign oil-related losses over longer
period than under present law. The longer period applies only to a
foreign oil-related loss which is sustained in a taxable year ending
before January 1, 1979, and which was incurred pursuant to a binding
contract to explore or to develop oil or gas property entered into on
or before July 1, 1974. Under this provision, not more than 15 percent
of the loss is recaptured for each of the first four taxable years begin-
ning with the first year for which a foreign tax credit is claimed on
foreign oil and gas extraction income. Thereafter, any remaining loss
is reen pt ured in accordance with present rules.
This provision benefits Sun Oil Company.
Rerenue effect
It is estimated that this provision will reduce budget receipts by
$21 million in fiscal year 1977 and $6 million in fiscal year 1978. How-
ever, the reduction in those years will be recaptured by increased re-
ceipts in the following years.
14. Definition of Foreign Oil-Related Income (sec. 1035(c) of the
bill)
Present ?aw
Under present law, the amount of the foreign tax credits allowable
for taxes paid with respect to foreign oil and gas extraction income is
limited to 50 percent (50.4 percent in 1976) of tfliat income. Any excess
credits arising under this limitation can only be used to offset foreign
oil-related income. Generally, oil and gas extraction income means







taxable income from the extraction of oil and gas and from the sale of
assets used in such extraction activities. Foreign oil-related income
includes taxable income from the extraction of oil and gas, the process-
ing of oil and gas into their primary products, the transportation of
the products, and the sale of assets used in such activities.
In addition, dividends and interest from a foreign corporation are
included in foreign oil-related income. Foreign oil-related income also
includes an allocable portion of dividends from a domestic corporation
which earns oil-related income if such dividends are treated as foreign
source income (because less than 20 percent of such corporation's gross
income is derived from U.S. sources). However, interest from a domes-
tic corporation earning foreign-oil-related income, which is likewise
treated as foreign source income if less than 20 percent of its gross
income is from U.S. sources, is not treated as oil-related income.
a. Interest paid by domestic corporations
Issue
The question is whether interest from domestic corporations should
be treated differently than dividends from domestic corporations (and
from interest or dividends from foreign corporations) for purposes of
determining foreign oil-related income.
Explanation of provision
This provision was proposed by Senator Bentsen. The provision re-
vises the definition of foreign oil-related income to include interest
from a domestic corporation provided the interest is treated as foreign
source income by reason of the fact that less than 20 percent of such
corporation's gross income is derived from sources within the United
States. As in the case of dividends included under present law, only
the portion of the interest attributable to foreign oil-related income
is included. The apportionment standards for foreign source income
(sec. 862 (b)) are to be used in making the allocation.
This provision affects many international oil companies (but not
Aramco).
Revenue effect
It is estimated that the inclusion of interest in oil-related income
will result in a decrease in budget receipts of $40 million in fiscal year
1977 and of $90 million thereafter.
b. Public utility income
Issue
The issue is whether income of a regulated public utility which hlias
some activities relating to the transportation and distribution of nat-
ural gas should be subject to the separate overall limitation as foreign
oil-related income.
Explanation of provision
This provision was proposed by Senator Curtis. The provision re-
vises the definition of foreign oil-related income so that it does not
include income from the transportation or distribution of natural gas
by a regulated public utility for use within its own regulated public
utility operations within the country in which it is incorporated and
in which the regulated public utility is located.
This provision affects IU International Corporation.







c. Sale of stock in foreign corporation joining in consoli-
dated return
Issue
The issue is whether income from the sale of stock in a foreign cor-
poration earning foreign oil extraction income or foreign oil-related
income should be treated in a manner similar to income from the sale
of assets of the same foreign corporation in cases where the foreign
corporation joins in the filing of a consolidated return with a U.S.
corporation.
Explanation of provision
This provision was proposed by Senator Bentsen. The provi-
sion clarifies the definition of foreign oil-related income and for-
eign oil and gas extraction income in the case of the sale of stock
of a foreign corporation entitled to be included as a member of a
consolidated group. Since the income from such a corporation is in-
cluded in the consolidated group for purposes of determining whether
the income is foreign oil-related or foreign oil and gas extraction in-
come, the sale of the stock is to receive the same treatment, to the extent
the assets of the company whose stock is sold were used for the produc-
tion of either foreign oil-related income or foreign oil and gas extrac-
tion income.
This provision benefits Tenneco, Inc.
15. Taxation of Foreign Oil-Extraction Income of Individuals
(sec. 1035(d) of the bill)
Present law
Under present law, individuals are subject to the same limitation as
corporations on the amount of foreign tax credits which can be claimed
against foreign oil-extraction and foreign oil-related income. Individ-
uals are thus limited to foreign tax credits equal to 50.4 percent of tax-
able extraction income in 1976 and 50 percent of taxable extraction
income in 1977 and future years. Furthermore, any excess credits aris-
ing under this limitation can only be used to offset foreign oil-related
income.
Issue
The issue is whether the 50-percent limitations is appropriate in the
context of noncorporate taxpayers, since unlike corporations, the
average tax rate of individuals may be lower or higher than the 48
percent rate.
Explanation of provision
This provision was suggested by Senator Fannin. The provision
limits the allowable foreign tax credit on foreign oil and gas extrac-
tion income of individuals to the average U.S. effective rate of tax
on that income. The provision achieves this result by establishing a
separate overall foreign tax credit limitation for foreign oil and gas
extraction income of taxpayers other than corporations.
This provision benefits the. Clara Miller Trust and individuals on
limited partnerships with the Hamilton Brother Corporation.







16. Creditable Taxes on Oil Payments Where No Economic In-
terest Exists (see. 1035(e) of the bill)
Present law
Under present law, as amended by the Tax Reduction Act of 1975,
no foreign tax credit is allowable for payments to a foreign country in
connection with the purchase and sale of oil or gas where the taxpayer
hasno economic interest in the oil or gas and either the purchase or the
sale is at a price which differs from the fair market price of the oil or
gas. This provision was intended to deny any foreign tax credit to oil
companies with respect to oil or gas which is owned by the foreign gov-
-ernment (e.g., oil which is described as nonequity oil or buyback oil)
where payments for the purchase of the oil owned by the foreign
country are disguised in part as the payment of a tax.
s188sue
The issue is whether taxpayers who have had an economic interest in
foreign oil, but which have been forced into an altered arrangement so
that they no longer have an economic interest in a particular oil field,
should be subject to this provision without some provision for a tran-
sitional period.
Explanation of provision
This provision was suggested by Senator Hansen. The provision
requires that section 901(f) is not to apply with respect to the pur-
chase and sale of oil or gas from a field if the taxpayer has had an
economic interest in the oil in that field and if, on or before March 29,
1975, thetaxpayer has made an investment with respect to the field.
This will be the case notwithstanding the fact that the taxpayer
purchases the oil or gas from that field at less than the fair market
value, including a discount which reflects compensation for the prior
investment, or sells at a price which differs from the fair market
value for the oil or gas. However, section 901(f) will apply in any
case for taxable years beginning after 1985.
The provision does not apply to any field with respect to
which no investment was made on or before March 29, 1975, even
if the field is located within the same concession area as another field
which is subject to the exception added by this provision. These
investments will be subject to the test of the oil or gas being bought
and sold at an armn's-length price.
This provision will affect the U.S. oil companies operating abroad
which have been subject to nationalization and which do not have
substantial excess foreign tax credits from other foreign countries. It
has been reported that this provision will benefit Mobil Oil Company
and other major oil companies operating in Iran.
Revenue effect
It is estimated that will result in a decrease in budget receipts
of $34, million in fiscal year 1977 and of $40 million in each year
thereafter through 1985.





20


17. Foreign Tax Credits Arising Through Oil and Gas Produc-
tion Sharing Contracts (sec. 1035(f) of the bill)
Present law
Under present law, a foreign tax credit is allowable only for income,
1war profits, and excess profits taxes paid or accrued to a foreign country
or to a possession of the United States. Amounts paid to a foreign gov-
ernment or a possession in other forms (such as royalty payments
for the rights to develop natural resources) are allowed only as a
deduction, even if designated by the foreign country as a tax. The
service is given authority to determine what payments qualify as
income taxes and thus are allowed as credits rather than as deductions.
Issues
Questions have arisen as to whether payments to a. foreign govern-
ment qualify as income taxes in the case of production sharing con-
tracts. Under these agreements the government retains ownership of
the mineral property while the oil company provides the services of
drilling and producing the oil. The oil company is generally com-
pensated for its costs by receiving the first production from the
property, with the remainder of the production divided between the
oil company and the foreign government according to negotiated
percentages. Under these agreements part of the share of the produc-
tion received by the foreign government (or by a government-owned
entity which in turns makes payments to the foreign government)
is designated as an income tax payment by the foreign government and
claimed as a credit by the oil company.
The Internal Revenue Service recently issued Revenue Ruling 76-
215, 1976 I.R.B. No. 23, holding that the contractor under a produc-
tion-sharing contract in Indonesia is not entitled to a foreign tax
credit for payments made by the government-owned company to the
foreign government. The grounds for this holding Were, in part, that
since the foreign government already owns all of the oil and gas, there
is no payment to the government by the contractor. Furthermore, even
if a payment by, or on behalf of, the contractor could be identified,
the IRS views such a payment as more in the nature of a royalty than
a tax.
The issue is whether taxpayers should be allowed to continue to treat
these payments as creditable taxes for a period of time while the pro-
duction sharing arrangements with the Indonesian Government are
renegotiated.
Explanation of provision
This provision was suggested by Senator Bentsen. The provision
allows a limited foreign tax credit for a limited period in the case of
production-sharing contracts to which Revenue Ruling 76-215 applies.
Under this provision, amounts which are designated by n foreign gov-
ernment imnder certain production-sharing contracts as income taxes
are treated as creditable income, war profits., and excess profits taxes
even though the amounts would not otherwise be treated ns creditable
taxes. The provision only applies to taxes not creditable by reason of
thaIt ruling.
However, the total amount treated as creditable taxes under this
provision is not to exceed the lesser of two amounts. The first amount






21


is the total foreign oil and gas extraction income with respect to pro-
duction-sharing contracts covered under the rule multiplied by the
U.S. corporate tax rate (generally 48 percent) less the otherwise allow-
able (if any) foreign tax credits attributable to income from those
contracts. The second amount is the total foreign oil and gas extrac-
tion income multiplied by the U.S. corporate tax rate (generally 48
percent) less the total amount of the otherwise' allowable foreign
tax credits (if any) attributable to the total foreign oil and gas extrac-
tion income.
This provision will apply only to production-sharing contracts
entered into before April 8, 1976, and will apply only with respect to
taxes designated as having been paid under such contracts before Jan-
uary 1,1982.
This provision a effects Huffington Oil Company, Natomas Company,
and a number of other small oil companies.
Revenue effect
It is estimated that this provision will decrease budget receipts by
$;23 million in fiscal year 1977 and $27 million in fiscal year 1978.
18. Source of Underwriting Income (sec. 1036 of the bill)
Present law
Under present law, the source of insurance underwriting income
is unclear. Neither the Internal Revenue Code nor the Income Tax
IRegulat ions set. forth a specific rule for determining the source of
insurance underwriting income. It is the position of the Internal Reve-
nue Service, however, that the source of such income is to be deter-
mined on the basis of where the incidents of the transaction which
produce the income occur. Under this rule, income produced from in-
surance underwriting contracts negotiated and executed in the
United States, regardless of the location of the insured risks, is gen-
erally deemed to be from sources within the United States. This rule
apparently applies even though the insurance contract is actually
written by a foreign company.
Iss ue
The source rule presently applied by the IRS to insurance under-
writing income is vulnerable to artificial manipulation by taxpayers.
By simply changing the place where a contract is negotiated and ex-
ecuted, a taxpayer can change the source of the underwriting income
produced by the contract. That source rule in some situations also can
result in double taxation. It is not uncommon for United States cor-
porations doing business abroad through foreign subsidiaries to nego-
tiate and execute insurance contracts in the United States which
cover its overseas operations. The insurance policies, however, fre-
quently must be issued in the foreign jurisdiction in which the in-
sured's risk is located in order to comply with local insurance laws or
for other business reasons. Although the underwriting income in
these circumstances generally would be subject to foreign taxation,
the income would be deemed United States source income, which in
turn would reduce the amount of the foreign tax credit available to
the taxpayer.






22


SThe issue is whether, in place of the source rule applied by the IRS,
a new source rule should be adopted under which the source of insur-
ance underwriting income would be the location of the risk insured.
Explanation of pro vision
This provision was suggested by Senator Fannin. The provision
establishes that the source of insurance underwriting income is to
depend upon the location of the risk. Underwriting income de-
rived from the insurance of U.S. risks would be income from
sources within the United States. All other underwriting income would
be considered income from sources without the United States. The
new source rule is not intended to change existing law with respect to
the determination of whether foreign source income is effectively con-
nected with the conduct of a trade or business within the United States.
This provision benefits the American International Group, Inc.
19. Third-tier Foreign Tax Credit Under Subpart F (sec. 1037
of the bill)
Present law
Under present law, when amounts which are foreign base company
income are included in the income of a domestic corporation under sub-
part F, a proportionate part of the foreign taxes paid by the
foreign corporation are deemed paid by the domestic corpora-
tion, and a foreign tax credit is available to the domestic corporation
with respect to those taxes. These rules are substantially parallel to the
foreign tax credit rules on actual distributions. However, this deemed-
paid credit is available for subpart F income only if the controlled
foreign corporation is a first-tier foreign corporation (which must be
at least 10-percent owned by a domestic corporation) or a second-tier
foreign corporation (which must be at least 50 percent owned by a first-
tier foreign corporation).
Issue
The issue is whether the foreign tax credit rules with respect to
amounts included in income under subpart F should be consistent
with the rules applicable to dividends actually distributed.
Explanation of provi'isions
This suggestfion was made by the staff in order to provide the same
tax treatment under Subpart F as applies generally in the case of the
foreign tax credit for third-tier subsidiaries. The provision makes
two changes to the present rules for compn)uting a foreign tax credit
with respect to amounts included in income under subpart F. First, the
amendment provides that the foreign tax credit is applicable with
respect to foreign taxes paid by a third-tier foreign corporation whose
.inditributed income is taxed to the shareholder. Second, the amend-
ment liberalizes the stock ownership test applicable to second-tier
foreign corporations.
Under the provision, a foreign corporation qualifies as a second-
tier foreign corporation if at least 10 percent of its voting stock is
owned by a first-tier foreign corporation, at least 10 percent of the
voting stock of which meliut be owned by a domestic corporation. A
foreign corporation qualifies as a third-tier foreign corporation if at
least 10 percent of its voting stock is owned by a second-tier foreign
corporation.





23


This will affect any company with subpart F income which has a
third-tier foreign subsidiary.
Re venue effect
This provision will reduce budget receipts by $4 million in fiscal
year 1977, $10 million in fiscal year 1978, and $10 million in fiscal year
1981.
20. Bank Deposits in the United States of Nonresident Aliens
and Foreign Corporations (sec. 1041 of the bill)
Present la to
Present law provides, in general, that interest, dividends and other
similar types of income of a nonresident alien or a foreign corporation
are generally subject to a 30-percent tax on the gross amount paid if
such income or gain is not effectively connected with the conduct of
a trade or business within the United States (sees. 871 (a) and 881).
However, a number of exemptions have been provided in the Code
from this 30-percent tax on gross income including an exemption for
interest derived from bank accounts.
In addition, various income tax treaties of the United States provide
for either an exemption or a reduced rate of tax for interest and divi-
dends paid to foreign persons if the income is not effectively connected
with the conduct of a trade or business within the United States.
Issue
The question is whether the present exemption for bank deposit
interest, which would otherwise expire at the end of the yea r should
be made permanent.
Explanation of provision
This is a House provision which was not changed by the Senate
Finance Committee. The provision continues the exemption in present
law for interest on deposits with persons carrying on the banking
business without any termination date. The present exemption for
interest of deposits expires for interest paid after Decemnber 31, 1976.
The provision makes the exemption for interest on deposits perma-
nent by eliminating the language of present law which would termini-
nate the provision for interest paid after December 31, 1976.
This affects many banks, particularly those located near a U.S.
border and those with significant international business.
Revenue effect
It is estimated that this provision will reduce budget receipts by
$55 million in fiscal year 1977, $115 million in fiscal year 1978, and
$145 million in fiscal year 1981.
21. Sales or Exchanges Giving Rise to Dividends (see. 1042 of the
bill)
P; 'cenjt law
Under present law, a distribution by a foreign corporation of appre-
ciated property is treated in the same manner that similar distributions
from a domestic corporation to an individual shareholder are treated.
That is, the shareholder is treated as having received a dividend equal
to the fair market value of the property and the distributing corpora-
tion reduces earnings and profits by the basis of the property distrib-





24


uted. Further, when a foreign corporation distributes the stock of a
second-tier foreign corporation to its U.S. shareholders, the earnings
and profits of the second-tier foreign corporation to the extent ac-
cumulated after 1962 will be subject to a tax as a dividend when such
earnings are distributed or are treated as having been distributed to
the U.S. shareholder. A recent court case has held that when the first-
tier foreign subsidiary is liquidated, the earnings and profits available
for dividend taxation are reduced by the basis in the second-tier
subsidiary.
Issue
The issue is whether the earnings and profits of a foreign corporation
are subject to possible double taxation when it distributes appreciated
property, and, if so, should relief be provided notwithstanding con-
trary court cases or the running of periods of limitations for bring-
ing refund claims.
Explanation of prov-ision
This provision was suggested by Senator Hartke. The provision adds
a special rule in the case of certain past liquidations of a foreign sub-
sidiary which entitles the taxpayer to apply the new provisions of the
law and obtain a refund or a credit of any overpayment by reason
of the application of the new provisions notwithstanding the fact
that the refund or overpayment would otherwise be prevented
by a court case or the statute of limitations. If a refund or a credit is
allowed, however, no interest is to be paid on the refund or credit for
any period prior to the date of enactment.
The situation provided for in the provision covers the case where a
foreign subsidiary is liquidated by its U.S. parent and in an earlier
year stock of a lower-tier foreign subsidiary was distributed to the
parent as a dividend. Since the stock of the lower-tier subsidiary -is
stock described in section 1248, the accumulated earnings with respect
to that stock are still subject to dividend treatment upon the sale or
exchange of the stock at a gain. This, in effect, could result in double
taxation of those earnings. Thus, the provision requires that the Secre-
tary of the Treasury in promulgating his regulations under section
367(b) write the rules dealing with the computation of earnings and
profits and basis of stock in such a manner so that double taxation is
avoided.
This provision benefits the H. H. Robertson Company:
22. Contiguous Country Branches of Domestic Life Insurance
Companies (sec. 1043 of the bill)
Present law
Under present law, a domestic mutual life insurance company is
subject to tax on its worldwide taxable income. If the company pays
forei-m 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.
Issue
As a general rumile, profits of a U.S. company although earned from
sources outside the United States should be subject to U.S. tax when
earned since those profits are available for distribution to the share-
holders of the company or are available to the company to be used
within or without the United States for new investments. However,








the profits derived by a Canadian branch of a U.S. mutual life insur-
ance company are not generally available for use other than as re-
serves and surplus of the Canadian policyholders and may not be used
to provide insurance for the U.S. policyholders. The issue is whether
this feature of mutuality, in which the earnings are restricted to bene-
fit the Canadian policyholders, distinguishes the branch operations
of a mutual life insurance company from the branch operations of
other businesses.
Explanation of provision
This provision was in the House bill and only minor changes were
made in it by the Senate Finance Committee.
Mutual companies.-The provision establishes a special system for
branches of U.S. mutual life insurance companies which are operated
in a contiguous country (i.e., Canada or Mexico). To be eligible for
this special treatment a mutual life insurance company must make
an election with respect to a contiguous country life insurance branch.
If a proper election is made there is excluded from each item in-
volved in the determination of life insurance company taxable income
the items separately accounted for in a separate contiguous country
branch account which the mutual life insurance company is required
to establish and maintain under the bill.
For purposes of this provision, a branch is a contiguous country
life insurance branch if it satisfies three conditions. First, it must issue
insurance contracts insuring risks in connection with the lives or health
of residents of a country which is contiguous to the United States (i.e.,
Canada or Mexico). Second, the branch must have its principal place
of business in the contiguous country for which it insures risks. Third,
the branch, if it were a separate domestic corporation, must. be able to
qualify as a separate mutual life insurance company.
The election to establish a separate contiguous country branch is to
be treated as a taxable disposition for purposes of recognizing any
gain by the domestic company. If the aggregate fair market value of
all the invested assets and tangible property which is separately ac-
counted for by the company in the branch account exceeds the aggre-
gate adjusted basis of those assets (for purposes of determining gain)
then the company is to be treated as having sold those assets on the
first day of the first taxable year for which the election is in effect at
the fair market value on that day. The net gain on the deemed sale of
these assets is to be recognized notwithstanding any other provision of
the Code.
The provision also contains rules for the taxation of the contiguous
country branch income if it is ever repatriated. First, payments, trans-
fers, reimbursements, credits, or allowances which are made from a
separate contiguous country branch account to one or more accounts
of the domestic company as reimbursements for costs (e.g., home office
services) incurred for or with respect to the insurance (incl tudini"
reinsurance) of risks accounted for in the separate branch account
are to be taken into account by the domestic company in the same
manner as if the payment, transfer, reimbursement, credit, or allow-
ance were received from a separate person.
If amounts are directly or indirectly transferred or credited from a
contiguous country branch account to one or more other accounts of





26

the domestic company they are to be added to the life insurance com-
pany taxable income of the domestic company except to the extent the
transfers are reimbursements for home office services.
The election provided by this provision may be made for any taxable,
year beginning after December 31,1975. Once an election is made it is
to remain in effect for all subsequent years except that it may be
revoked with the consent of the Secretary.
Transfers by stock companies.-The provision also establishes a
special rule in the case of stock life insurance companies operating in
Canada or Mexico. While it is easier for a stock life insurance coinm-
pany to operate through a subsidiary organized under foreign law
than it is for a mutual company, problems would be encountered in
transferring an existing business to a foreign subsidiary since such. a
transfer would require the satisfaction of the Secretary that one of
its purposes was not the avoidance of Federal income taxes. Since the
provision contains special rules for deemed transfers in the case of
mutual life insurance companies, the committee felt it was appropriate
to provide similar rules in the case of actual transfers by stock coinm-
pa nies to a contiguous country subsidiary.
Under the provision a domestic stock life insurance company which
has a contiguous country life insurance branch may elect to transfer
the assets of that branch to a foreign corporation organized under the
laws of that contiguous country without the application of section
367 or 1491. The insurance contracts which may be transferred to the
subsidiary include only those of the types issued by a mutual life in-
surance company.
The provision requires that the net gain on the transfer be subject to
tax. To the extent that the aggregate fair market value of all the in-
vested assets in tangible property which are separately accounted for
in the contiguous country life insurance branch exceeds the aggre-
gate adjusted basis of all of these assets for purposes of determining
gain, the domestic life insurance company is to be treated as having
sold all of the assets on the first day of the first taxable year for which
the election is in effect.
This provision also provides that the stock of the subsidiary for
purposes of determining the income tax of the domestic stock life
insurance company is to be given the same treatment as is accorded the
assets of a contiguous country branch of a mutual company under the
mutual company provision. Similarly, any dividends paid by the sub-
sidiary to the domestic life insurance company will be added to its life
insurance company taxable income.
The provisions applies to taxable years beginning after December
31,1975.
These provisions affect both mutual and stock companies with oper-
ations in Canada.
Revenue effect
It is estimated that the mutual and stock company provisions will
result in a decrease in budget receipts of $4 million in fiscal year 1977
and of $8 million thereafter.





27


23. Transitional Rule for Bond, Etc., Losses of Foreign Banks
(sec. 1044 of the bill)
Present law
The Tax Reform Act of 1969 (Public Law 91-172) eliminated the
preferential treatment accorded to certain financial institutions for
transactions involving corporate and government bonds and other
evidences of indebtedness. Previous to that legislation these financial
institutions were allowed to treat net gains from these transactions as
capital gains and to deduct the losses as ordinary losses. The 1969 Act
(sec. 433, amending sec. 582 of the Code) provided parallel treatment
to gains and losses pertaining to these transactions by treating 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.
Issue
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.
Explanation of provision
This provision was added by the House and no change was made in
it by the Senate Finance Committee. The provision establishes a speciIal
tra nsitional rule for corporations which would be banks except for the
fact that they are foreign corporations. Net gains (if any) for a tax-
al)e year on sales or exchanges of bonds, debentures, notes, or other
evidences of indebtedness are considered as gain from the sale or ex-
change of a capital asset to the extent that such gain does not exceed
the portion of any capital loss carryover to the taxable year where
such capital loss is attributable to the same types of sales or exchanges
for taxable years beginning before July 12, 1969. In addition, a refund
or credit of any overpayment as a result of the application of the pro-
vision is not precluded by the operation of any law or rule of law
(other than section 7122, relating to compromises) so long as the claim
for credit or refund is filed within one year after the date of the enact-
ment of the provision.
The provision applies to taxable years beginning after July 11, 1969.
This provision will have general application to foreign banks with
U.S. business. The Royal Bank of Canada has supported the provision.


7T4-375-76---3






28


24. Western Hemisphere Trade Corporations (sec. 1052 of the bill)
Present law
Present law provides that an affiliated group filing a consolidated
return is permitted to average the foreign source income and foreign
taxes of any Western Hemisphere trade corporations. ("WHTCs"')
included in the group with the foreign source income and foreign taxes
of non-WHTCs included in the group if both derive their income from
the same country and the per-country foreign tax credit limitation
is used. However, except in the case of a public utility, the averaging of
foreign income and taxes of WHTCs and non-WHTCs is not allowed
if the overall foreign tax credit limitation is elected.
Issue
The bill generally would repeal both the peri-cointry limitation and
the WHTC provisions. Thlie issue is whether there are circumstances
under which affiliated groups thus required to use the overall limita-
tion should be. permitted to average the foreign income and taxes of
WHTCs and non-WHTCs during the four-year phase-out period of
the WHTC provisions.
Ex.plrationt of procis;on
This provision was sug",,ested by Senator Cnirtis. The provision per-
mits a foreign corporation which is treated as being a domestic com-
pany for consolidated return purposes to average its foreign taxes with
other corporations in the group if they each derive 95 percent or more
of their gross income from sources within a contiguous country and
are primarily engaged in mining and related transportation in that
contiguous country.
This provision is applicable to taxable years beginning during the
years 1976 through 1979, the four year phase-out period of the WHTC
provisions.
This provision affects the Hanna Mining Company.
25. Treatment of Certain Individuals Employed in Fishing As
Self-Employed Individuals (sec. 1207 of the bill)
Present lawu,
Under the present law, the Internal Revenue Service usually treats
individuals employed on fishing boats, or on boats eno'aged in taking
other forms of aquatic animnial life, as regular employees. As a result.
operators of the boats must withhold taxes from the wages of these
crewmn,. and must also deduct and pay the taxes on employees and
employers under the Federal Insurance Contributions Act (the social
security taxes).
Issue
The issue is whether fishinim boat crewmen whose sole remuneration
is a share of the catch should be treated as regular employees or as self-
employed.
Exvpianation of proi';.'on
Thi, p)rovision was su.''gg,.sted by Senator Hathaway. The provision
Ill she-d provides that 1 boat crewmen, under certain circumstances,
shall be treated as self-employed for purposes of income tax withhold-






29


ing from wages. the self-employment tax, the Federal Insurance Con-
tributt ions Act taxes, and the social security laws. Crewmen are to be
treated as self-employed if their only remuneration is a share of the
boat's catch, or, in the case of an operation involving more thaii one
boat, is a share of the catch of the entire fleet, provided that the oper-
ating crew of their boat is normally made up of fewer than 10 indi-
viduals.
To achieve this, the provision amends the definitions of employment
(sec. 3121 (b) of the Code), the definition of a trade or business {(sec.
1102(c)), and the definition of wages for purposes of withholding)
(sec. 3401(a)). In addition, amendments are made to the definitions
of employment and of a trade or business in the parallel social security
statutes.
This provision alleviates many of the recordkeeping requirements
of the small boat operators. However, in order to permit the Internal
Revenue Service to maintain a method of insuring that the crewmei-
to be treated as self-employed correctly report their income, the
provision also requires boat operators to report the identity of
the self-employed individuals serving as crewmen, as well as tlhe
portion of the catch allotted to that individual. In addition, in (,rder
to allow the Service to compute the total proceeds of the catch, if niec-
essary, the boat operator is also to report the peirce(.tage of his owuT
share of the catch. Furthermore, such a boat operator is also to pro-
vide each of the self-employed crewmen a written statement on or
before January 31 of the succeeding year showing" the information
reported by the boat operator with respect to that crewman for thi
preceding calendar year.
The provisions providing for tax treatment of crewmen as self-
employed when employed under the circumstances (le,-cvibed above are
to be effective with respect to services performed after December 31,
1971, in taxable years ending after that date. The provisions p)ertainingo-
to the new reporting requirements of boat operators apply to calendar
years beginning after December 31, 1976.
The provision covers situations where the operating crew of the
boat upon which the crewmen serve consists of fewer than ten individ-
uals, and the sole remuneration of these crewmen consists of a share
of the catch of the boat, or, in the case of an operation involving more
than one boat, consists of a share of the catch of the entire group of
boats, it is estimated that this provision will decrease budget receipts
by $65 million over the next five fiscal yea rs.
This provision will benefit many small fishing operations, including
those in New England.
26. Tax Treatment of Certain 1972 Disaster Loans (sece. 11303 of
the bill)
Present 7i(,n
Under present law (sec. 165), taxpayers are generally allowed' ti0
deduct their losses sustained during the taxable year, including losN'.
attributable to fire, storm and other casualty, to the extent that such
losses are not compensated for by insurance or otherwise.1 In tlhe
case of any loss attributable to a major disaster which occurred iin
1 Individuals generally are allowed to dt-duct their losses of property (not connect, d
with their trade or business) only to the extent that the loss exceeds $I0j : losses attrib-
utable to an individual's business are fully deducible.





30


an area authorized by the President to receive disaster relief, a special
rule allows the loss, at the election of the taxpayer, to be deducted
on the return for the year immediately preceding the year of the dis-
aster (that is, the loss may be deducted on the return which is gen-
erally filed in the year in which the disaster occurs). In a case where
a deduction resulting from a loss is claimed in one year, and compen-
sation is paid with respect to that loss in a later year, the amount
of compensation is generally required to be taken into income by the
taxpayer under the tax benefit theory.
Issue
Certain cases arising in the past have come to the attention of the
committee in which individuals who were hard hit by disasters, such
as flood, claimed a deduction with respect to the disasters, unaware,
in many cases, that they might later receive compensation, or partial
compensation, for their loss. In some instances, the compensation
may be received in a year for which the taxpayer is in a higher tax
bracket than he was in for the year for which the disaster loss deduc-
tion was claimed. As a result, the taxpayer may be required to pay
more tax, with respect to the compensation or reimbursement, than
would have been owing if he had not claimed the deduction in the
first place. The issue is whether such tax treatment is appropriate
under these circumstances.
Explanation of provision
This is a House provision in which the Senate Finance Committee
made no change. The provision requires that, under certain circum-
stances, in the case of a loss attributable to a disaster which occurred in
1972, in an area designated by the President as a disaster relief area,
the tax on the first $5,000 of compensation received with respect to that
loss is not to exceed the tax which would have been payable if the
$5,000 (or lesser) deduction had not been claimed. This treatment
applies only if the taxpayer elects to come under these provisions, in a
time and manner to be prescribed in regulations, and is subject to
certain conditions.
In order for the taxpayer to elect the benefits of this provision, he
must have suffered a disaster loss for the year 1972, and to be fully
eligible under this provision his adjusted gross income for the year
in which he claimed the disaster loss as a deduction (either 1972 or
1971, as the case may be) cannot have exceeded $15.000 ($7.500 in the
case of a married individual filing a separate return). In those cases
where an individual who is otherwise eligible under this provision has
adjusted gross income in excess of $15,0600 (or $7.500, whichever ap-
plies), the 15,000 limit is to be reduced dollar-for-dollar to the extent
his adjusted gross income exceeds $15,000.
This provision is intended primarily to benefit certain taxpayers
who suffered flood losses in Pennsylvania, South Dakota, and West
Virginia.
This provision shall apply to payments received after December 31,
1973, in taxable years ending after such date.






31


Revenue effect
This provision will reduce budget receipts by $45 million in the
transition period, $15 million in fiscal year 1977, $15 million in fiscal
year 1978, and less than $15 million in fiscal year 1979.
27. Tax Treatment of Certain Debts Owed by Political Parties to
Accrual Basis Taxpayers (sec. 1304 of the bill)
Present law
Under present law, any deduction generally allowable for bad debts
(sec. 166) or for worthless securities (sec. 165 (g)) is not allowed for
a worthless debt owned by a political party. This provision applies
to all taxpayers other than a bank (as defined in sec. 581), but where
the debt arises out of the sale of goods or services, the provision
affects only taxpayers utilizing the accrual method of accounting
(because only these taxpayers would have taken into income the
receipts which give rise to the debt).
The provision in present law defines political parties to include all
committees of a political party and all committees, associations, or
other organizations which accept contributions or make expenditures
on behalf of any individual in any Federal, State or local election.
Issue
The question is whether or not the concern which gave rise to the
provision in present law (i.e., that businesses will make concealed
contributions to campaigns by providing services and not collecting
the resulting debts) should be overridden in some cases where tax-
payers in the business of providing services to campaigns have debts
which cannot be collected.
Explanation of provision
This provision was in the House bill but that version of the bill ap-
plied retroactively to open years. The Finance Committee made this
provision applicable only to years beginning after 1975.
The provision adds an exception to the provision disallowing a
deduction for bad debts owed by political parties. The exception
applies only to taxpayers who use the accrual method of accounting.
These taxpayers are to be allowed a bad debt deduction with respect
to debts which are accrued as a receivable in a bona ftde sale of goods
or services in the ordinary course of their trade or business.
This exception is limited to those cases in which 30 percent of all
of the receivables accrued in the ordinary course of all of the trades
or businesses of the taxpayer are due from political parties. Thus, the
exception is limited to those taxpayers whose sales to political parties
(including political campaigns and candidates) constitute a major
portion of their trades or businesses.
Furthermore, the bad debt deduction is to be allowed only if the
taxpayer has made substantial continuing efforts to collect on the
debt. Thus, a taxpayer must make good faith efforts over a period of
time to collect, the debt and must be able to document those efforts.
It has been stated that the retroactive feature of this provision
would have applied at least to companies, owned by Mr.: Guggenheim
and Mr. Dierdorf. With prospective application only, this provision





32


would apply to any person an the accrual method of accounting who
has outstanding bad debts from political parties or political cam-
p)ailgls.
28. Prepublication Expenses (sec. 1305 of the bill)
Present law
Present law (sec. 174 (a) (1)) permits, under certain circumstances,
an itemized deduction for research and experimental expenditures
otherwise chargeable to a taxpayer's capital account. The regulations
under this provision define research and experimental expenditures as
expenditures incurred in connection with a taxpayer's trade or business
which represent research and development costs in the experimental
or laboratory sense. The regulations specifically exclude expenditures
for research in connection with literary, historical, or similar projects.
In Rev. Rul. 73-395,1 the Internal Revenue Service held that the
costs incurred by an accrual basis taxpayer in the writing, editing, de-
sign and art work directly attributable to the development of textbooks
and visual aids do not constitute research and experimental expendi-
tures under section 174. The Serv-ice further held that these costs can-
not be inventoried (under sec. 471) but instead represent expenditures
that must be capitalized (under sec. 263) and maybe depreciated (un-
der sec. 167 (a)).
However, the ruling also stated that expenditures incurred in the
actual printing and publishing of textbooks and visual aids should
be inventoried (under sec. 471) with apart of the costs being appor-
tioned to books and visual aids still on hand at the end of the tax-
able year. Also, expenditures for manuscripts.and visual aids that are
abandoned may be deductible as losses (under sec. 165).
On March 17, 1976, the Internal Revenue Service announced 2 that
it had begun a study project as a result of questions regarding the
application of Rev. Rul. 73-395 to certain prepublication expenses of
the publishing industry. The Service will study the application of sec-
tions 162 (dealing with the deduction of trade or business expenses),
263 (treatment of capital expenditures), and 471 (general rule for
inventories) to prepublication costs within different segments of the
industry.
The Service stated that the application of these sections is not
adequately explained in Rev. Rul. 73-395, and that the project is
expected to result in the publication of regulations and/or additional
revenue rulings. It is also likely that Rev. Rul. 73-395 will be modified
and clarified or superseded.
Pending completion of this project, the Service is suspending audit
and appellate activity with respect to cases in which the deductibility
of 'tlese prepublication expenses of publishers is an issue. No further
action will be taken in these cases except as necessary to protect the
interest of the Government.
In the case of authors, the Internal Revenue Service requires capi-
talization (under sec. 263) of prepublication travel and research ex-
penditures incurred while researching, writing, and arranging material
for a book. These expenditures are treated as capital items because they
do not qualify as deductible research and experimental expenditures
197 3-2 C.B. 87.
2 Press Release IR-1575.






33


under the regulations for section 174 and because the Service considers
them amounts expended for securing a copyright which must be capi-
talized under the regulations for section 263.
Under section 167, these expenditures may be depreciated over their
useful lives. If the actual useful life of a copyrighted work can be esti-
mated, that period is used for determining the depreciation rate. Other-
wise the 28-year copyright term is used.
A decision of the United States District Court, Central District,
California,3 however, held that a taxpayer, found to be in the business
of writing, could deduct as ordinary and necessary business expenses
(under section 162(a)) the expenses incurred for meals, lodging and
travel while researching, writing, and arranging material for a book.
The court explicitly held that the writer's expenditures were not ex-
penses incurred for the production of a book by one not in the trade or
business of writing; nor were they expenses incurred for securing a
copyright. In Rev. Rul. 73-395. the Service announced that it would
not follow this judicial decision.4
Issue
The issue is whether the tax accounting practices of publishers and
authors are to be sanctioned by enacting this provision which would
suspend the Service's enforcement of its interpretation of the relevant
tax law and which would permit publishers and authors to continue
their customary practices until new regulations are issued, regardless
of whether or not such practices followed the tax law, particularly
with regard to section 174 and the regulations and rulings under that
sect ion.
Explanation of provision
The House bill contained a provision relating to the prepublication
expenses of publishers. Senator Bentsen suggested certain modifica-
tion in this provision. Its extension to cover authors was suggested
by Senator Ribicoff.
The provision generally allows publishers and authors to continue
their customary treatment of prepublication expenditures without re-
gard to Rev. Rul. 73-395 and provides for new regulations. The pro-
vision is substantially the same as the provision in the House bill,
except that it extends its application to authors.
The prepublication expenditures affected by the provision are those
paid or incurred in connection with the taxpayer's trade or business
of publishing or writing for the writing, editing, compiling, illus-
trating, designing or other development or improvement of a book,
teaching aid, or similar product.
The provision allows taxpayers to treat their prepublication ex-
penditures in the manner in which they have been treated consistently
by the taxpayer in the past until new regulations are issued with re-
gard to these expenditures after the date of enactment of the bill.
Any regulations issued by the Internal Revenue Service would apply
only to taxable years beginning after their issuance. Until these regu-
3, tern v. United States. 1971-1. U.S.T.C. 9375. The case involved two issues: (1)
whether the taxpayer was engaged in the business of writing, and (2) whether traveling
expenses were deductible as ordinary and necessary business expenses or constituted
non-deductible expenditures for the improvement of a capital asset.
4 The Government said that it did not appeal the case because it had erroneously stipu-
lated to the effect that "If the taxpayer was determined to be in the business of being a
writer, the traveling expenses in question were ordinary and necessary."






34


lations are issued, the Internal Revenue Service would administer the
application of sections 61, (as it relates to cost of goods sold) 162, 174,
263.and 471 to the prepublication expenditures of both publishers and
authors without regard to Rev. Rul. 73-395. In addition, as indicated
above, the Service would administer these sections in the same manner
as they were consistently applied by taxpayers prior to the issuance of
Rev. Rul. 73-395. If a taxpayer did not consistently follow a specific
tax accounting method, his returns would be treated by the Service in
accord with usual administrative procedures.
The Encyclopedia Britannica initially requested the amendment
benefiting publishers. An ad hoc committee formed by some other
members of the publishing industry has also supported this provision.
Both the Encyclopedia Britannica and the ad hoc committee also
sought administrative suspension of Rev. Rul. 73-395. The modifica-
tions added by the Senate Finance Committee were recommended by
the "San Antonio Light," among others.
Only publishers who have deducted prepublication expenses cur-
rently would benefit from the bar against IRS application and en-
forcement of the Service's interpretation that the law requires that
such expenses be capitalized. Publishers who have capitalized such
expenses would not benefit from this provision.
The amendment affecting authors was requested by The Authors
League of America, Inc., New York, New York. The authors' amend-
ment would apply to all professional writers.
Any regulations issued by the Service on publishers' or authors'
prepublication expenditures after the date of enactment will apply
prospectively only to taxable years beginning after their issuance.
The provision will have little or no revenue effect because publishers
and authors benefitted by the suspension of Rev. Rul. 73-395 would
have neither reported nor paid the past tax liabilities assessed by the
Service pursuant to its interpretation of the law.as stated in that rul-
ing. However, if the Service had not suspended audit and appellate
activity in cases arising from its legal interpretation as evidenced
in Rev. Rul. 73-395, and if no legislative bar on enforcement were en-
acted, publishers' past, due tax liabilities could amount to several
hundred million dollars. Any change in authors' liabilities probably
would be negligible.
29. Treatment of Face Amount Certificates (sec. 1307 of the bill)
Present law
In general, present law (sec. 1232) provides that the amount of dis-
count that arises where a corporation issues a bond, debenture, note,
certificate or other evidence of indebtedness for a price less than the
face amount payable at maturity is treated as ordinary income. The
Tax Reform Act of 1969 amended this provision to provide that
the discount attributable to a bond, note, certificate or other evidence
of indebtedness issued by a corporation after May 27, 1969. is to be
included in the holder's income on a ratable basis over the term of
the obligation.
In 1971, the Internal Revenue Service issued regulations under sec-
tion l,22 interpreting the changes made by the Tax Reform Act of
1969. These regulations provided that certain deposit arrangements





35

with financial institutions made on or after January 1, 1971, which
arrangements provide that interest will be deferred until maturity
(i.e., certain certificates of deposit, time deposits, bonus plans, etc.
issues bv banks and similar financial institutions) are subject to the
ratable inclusion rules under section 1232. Under these regulations, the
application of section 1232 to face-amount certificates (as defined in
section 2(a) (15) of the Investment Company Act of 1940) was re-
served.1
Subsequently, on October 9, 1973, the Internal Revenue Service
proposed further regulations which provided that a face-amount cer-
tificate issued by a corporation after March 31. 1974. would be subject
to the ratable inclusion rules under section 1232. These regulations
were issued in final form on March 29, 1974, applicable to face-
amount certificates issued after December 31, 1974. The application
of these regulations was subsequently postponed by the Internal Rev-
enue Service on two separate occasions in order to provide Congress
an opportunity to clarify its views as to the appropriate tax treatment
in these cases. Pursuant to the latest postponemnnt, a face-amount
certificate issued by a corporation after December 31, 1975, is subject
to the ratable rules under sectionn 1232. Thus, under these regulations
the amount of any original issued discount attributable to a face-
amount certificate issued after December 31, 1975, must be included
in the gross income of the holder on a pro rata basis over the term
of the certificate. The amount that, must be ratably included in gross
income is the difference between the amount paid by the purchaser and
the amount received by him at maturity. Further a corporation issuing
a face-amount certificate after December 31, 1975, must amortize the
discount over the life of the certificate.
On November 26, 1975, Investors Syndicate of America (I.S.A.), a
corporation that issues face-amount certificates, filed an action for a
declaratory judgment that these regulations, relating to face-amount
certificates be declared invalid. This suit is currently pending in the
United States District Court for the District of Columbia.
On December 23, 1975, an action seeking a temporary restraining
order and a preliminary injunction to enjoin the enforcement of these
regulations was filed by Huntoon Paige & Company, Inc., and Asso-
ciation for Investment in United States Guaranteed Assets, Inc., in
the U.S. District Court for the Southern District of New York. On
December 30. 1975, the Court denied the plantiff's request and dis-
missed the action.
Issue-
The issue is whether original issue discount attributable to a face-
amount certificate should be included in the gross income of the holder
ratably over the term of the certificate or included at the time of actual
receipt (usually at the maturity of the certificate).
1 Under section 2(a)(15) of the Investment Company Act of 1940, a "face-amount
certificate means any certificate, investment contract, or other security which repTre"nlts
an obligation on the part of its Issuer to pay a stated or determinable sum or sums at a
fixed or determinable date or dates more than twenty-four months after the date of
Issuance, in consideration of the payment of periodic installments of a stated or deter-
mniinable amount (which security shall be known as a face-amount. certificate of the
"installment type") : or any sPecirity which represents a similar obligation on the part of
a face-amount certificate company, the consideration for which is the payment of a
single lump sum (which security shall be known as a "fully paid" face-amount certificate).






36


Explanation of provision
This provision was suggested by Senator Mondale. The provision
amends present law (sec. 1232(d)) to provide that face-amount
certificates are not subject to the rules under section 1232, but rather
are to be taxed under section 72. As a result, the, amount of discount
attributable to a face-amount certificate would not be ratably included
in the gross income of the holder over the term of the certificate.
Instead, the amount of discount would be included in the gross income
of the holder upon actual receipt by him either at maturity or upon
a premature cancellation. If the holder exercises an option to take
annual payments from the corporation in lieu of a lump sum at
maturity, the payments will be taxed like annuities are presently
taxed under section 72, i.e., a portion of each payment received would
be included in gross income and the portion attributable to the con-
sideration furnished would be excluded.
The corporation issuing the certificate would be entitled to an inter-
est deduction in each taxable year equal to the amount of discount
accruing within that taxable year.
The provisions apply to a face-amount certificate as defined in sec-
tion 2 (a) (15) of the Investment Company Act of 1940.
The amendment would apply to face-amount certificates issued
after December 31,1975.
The provision primarily benefits Investors Diversified Syndicate.
Revenue effect
It is estimated that enactment of this provision will reduce tax
liability by less than $100,000 in 1976, $150,000 in 1977, and about
$500,000 in 1979.
30. Income From Lease of Intangible Property as Personal Hold-
ing Company Income (sec. 1308 of the bill)
Pre.ent law
Under present law, a corporation which is a personal holding com-
pany is taxed on its undistributed personal holding company income
at a rate of 70 percent (sec. 541). A corporation is a personal holding
company where five or fewer individuals own more than 50 percent in
value of its outstanding stock and at least 60 percent of the corpora-
tion's adjusted ordinary gross income comes from certain types of
income.
Under present law, amounts which a corporation receives from rent-
ing or leasing corporate property to a 25 percent or larger shareholder
are treated as personal holding income, but only if the corporation
derives over 10 percent of its total income from other types of personal
holding company income (sec. 543(a)(6)). The Internal Revenue
Service has published a revenue ruling holding that amounts which
a corporation receives for leasing intangible property (such as a
license to use or distribute a secret process or trade brand) to such a
shareholder are to be treated as ordinary royalty income and not as
income tested under section 543(a)(6) (Rev. Rul. 71-596). Conse-
quently, the full amount of the license payments becomes personal hold-
ing company income in the category of "royalties" (sec. 543(a) (1),
regardless of how much income of other types the corporation may
have.






37


Is88se
The issue is whether, if intangible property is licensed to a share-
holder and used in an active trade or business, the corporation's income.
is closer to a rental situation and should be governed by the rule relat-
ing to use of property by a shareholder rather than by the rule for
ordinary royalties. In other words, should amounts received from a
license of a patent or other intangible property to a 25 percent or
greater shareholder be personal holding company income only if over
10 percent of the corporation's total income is derived from other
personal holding company income sources?
Explanation of provision
This provision was presented by Senator Talmadge at the request of
Senators Sparkman and Allen. The provision requires that amounts
received under a lease of intangible personal property to a 25 percent
or greater shareholder are to be governed by the rule that now applies
to a corporate lease of tangible property to such a shareholder. Under
this rule, the full amount received by the corporation for the siaire-
holder's use of such property is not automatically treated as personal
holding company income. WVhether such income is trezited as personal
holding company income depends on whether the corporation derives
more than 10 percent of its total income from other personal holding
company sources.
The provision imposes a limitation, however, so that payments
received from a lease of intangible property to a shareholder are to
be tested under section 543(a) (6) only if the intangible assets are
part of an integral group of assets consisting of tangible and intangible
assets which the shareholder uses in actively ca rvying on his trade or
business. If the shareholder does not use the license or other intangible
asset (along with tangible assets) in carrying on his business, the li-
cense payments received by the corporation are to be treated as ordi-
nary royalties governed by the present rules of section 543 (a) (1) or. if
appropriate on the facts, under other rules relating to mineral, oil
or gas royalties (sec. 543 (a) (3)) or copyright royalties (sec. 543 (a)
(4)).
The amendment to the general rule of section 543(a) (6) relating
to intangible property is effective for corporate taxable years ending
after December 31, 1964.
This provision affects the Montgomery Coca Cola Bottling Company.
31. Excise Tax on Parts for Light-Duty Trucks and Buses (sec.
1310 of the bill)
Present law
The Revenue Act of 1971 repealed the 10-percent excise tax on light-
duty trucks and buses (those with gross vehicle weight of 10,000 pounds
or less). As a result, truck and bus parts and accessories sold by the
vehicle manufacturer as part of (or in connection with the sale
thereof) a light-duty truck or bus are not subject to tax-neither the
10-percent tax that used to be imposed on the vehicle, nor the 8-percent
tax on truck parts and accessories. Also, if a truck parts-or accessories
manufacturer sells parts or accessories to a manufacturer of light-duty
trucks for use in "further manufacture" of those trucks, the parts and
accessories are not subject to tax. However, if the truck parts manu-





38


facturer sells parts separate from the light-duty trucks and the in-
stallation of those parts by a retail truck dealer technically is not
"further manufacture" of the trucks, then the manufacturer's excise
tax of 8 percent applies. This is so even though the part or accessory
is sold to the retail customer at the same time he purchases the tax-
exempt light-duty truck or bus.
Issue
The issue is whether truck or bus parts sold separately by a manufac-
turer to a retail dealer for installation on an exempt light-duty truck
or bus at the time of its retail sale should bear the 8-percent excise
tax when the sale of such a part would be exempt if made to a truck
manufacturer for inclusion on a "light-duty" truck.
Explanation of provision
This provision was presented by Senator Talmadge. It provides that
the 8-percent manufacturers excise tax on trucks or bus parts and acces-
sories is to be refunded or credited to the manufacturer in the case of
any part or accessory sold on or in connection with the first retail sale
of a light-duty truck or bus. Thus, those parts and accessories are to be
effectively treated the same as the parts and accessories that actually
are a part of the tax-exempt truck as delivered from the manufacturer.
The credit or refund is not intended to cover replacement parts even if
ordered at the time of the purchase of the truck, but only those parts
and accessories which are to have original use on the purchased truck.
The House bill contains no comparable provision.
This provision is to apply to parts and accessories sold after the date
of enactment. (The Committee Report incorrectly states that it ap-
plies to parts sold on or after July 1, 1976.)
The beneficiaries of this provision would be purchasers of light duty
trucks and buses.
Revenue effect
This provision is estimated to result in annual revenue losses of
-about $3 million. This revenue would otherwise go into the Highway
Trust Fund (through September 30, 1979).
32. Certain Franchise Transfers (sec. 1311 of the bill)
Present law
Section 1253, which was added to the Internal Revenue Code by
the Tax Reform Act of 1969, provides generally that the transfer
of a franchise, trademark, or trade name shall not be treated as a sale
or exchnn.ye of a capital asset if the transferor retains any significant
power, right, or continuing interest with respect to the subject matter
of the franchise, trademark, or trade name.
Gain which would be treated as ordinary income pursuant to sec-
tion 1253 (unlike gain which would be treated as ordinary income
under other sections of the Code, e.g., sections 1245, 1250, 1251,
and 1252), is not treated asan unrealizedd receivable" of a partnership
which would have the effect of causing ordinary income upon certain
partnership distributions, payments in liquidation of a partnership
interest, or sales of other dispositions of partnership interests.
Section 1253 applies to all transfers taking place after December 31,
1969. Unlike certain other provisions of the 1969 Act, no exception was






39


made for transfers occurring after December 31, 1969, pursuant to
contracts which were in effect prior to that date.
Issues
The first issue is whether the rules providing ordinary income treat-
ment for certain transfers of rights under a franchise, trademark or
trade name should also apply to partnership transactions involving a
shift in ownership of such rights.
The second issue is whether a transitional rule should be provided
whereby transfers made after 1969 pursuant to contracts in existence
before that time should be exempted from section 1253.
Explaimationi of provision
This provision was presented by Senator Bentsen. The provision re-
quires that, with respect to certain partnership distributions, sales of
partnership interes-:ts, and d(listributions in liquidation of partnership
interests, the term "unrealized receivable" is to include the ordinary
income element which would have been recognized had the partnership
transferred a frainnliise, trademark, or trade name.
The provision also contains special tninsitional rules which pro-
vide that section 1253 will not apply to a transfer of a franchise, trade-
mark or trade name if (1) the transfer is pursuant to a contract that
was in existence prior to January 1, 1970, (2) the contract relates to a
trade or business in which a )professional practice is involved, and
(3) the transfer is made to a person who immediately before the trans-
fer is an employee or partner of the transferor. This rule is intended
to allow certain owners of professional practices who, prior to 1970,
had made arrangements to transfer their practices to employees or
partners not to have the provisions of section 1253 apply to such
transfers. However, in determining whether the transferor is en-
titled to capital gain treatment on such a transfer, the transfer will
be subject to the ordinary rules of law relating to whether there had
been a "sale or exchange" of a "capital asset". This new transitional
rule is to apply in c,,ses where there is a contract to transfer in existence
on January 1, 1970, whether or not such contract is binding on the
parties at such time. The transitional rule is also to apply only where
a professional practice is involved. However, where a professional
practice is involved and there is a related business which is trans-
ferred at the same time as part of the same agreement, such a transfer
will be covered by the transitional rule.
This transitional rule is further limited by the requirement that the
transfer must be made to a person who, immediately before the trans-
fer, is an employee or partner of the transferor. Generally, this re-
quirement is designed to limit the transitional rule to situations where
the transferor and the transferee have had an ongoing relationship
prior to January 1, 1970. and such ongoing relationship had, in part,
been carried on in the assumption that the transferee was to be able
to acquire the business over a period of time or at some time in the
future.
The amendment to the partnership provisions (sec. .751(c)) is to
apply to transactions occurring after Dc-cember 31. 1976, in taxable
years ending after that (late. The transitional rules for section 1253
are to apply to transfers made after December 31, 1969, subject to the
conditions specified above.





40


The Texas State Optical Company and perhaps others would be
beneficiaries of this provision.
33. Clarification of an Employer's Duty to Keep Records and to
Report Tips (see. 1312 of the bill)
Present law
There has been some dispute regarding an employer's duty to report
to the Internal Revenue Service charge account tips received by his
employee (for example, a waiter or waitress) but not included in the
monthly total tip amount usually reported by the employee to the
employer. However, under Revenue Ruling 76-231, released May 26,
1976, the Service announced that employers are to be required to report
such charge account tips.
Present law (sec. 6053 (a) of the code) requires employees to report
all tips received (including charge account tips) to their employers,
usually on a monthly basis. The tips required to be reported to employ-
ers are tips received and retained after any tip-splitting (such as by
waiters and waitresses with busboys) or tip-pooling (such as by a
waiter with other waiters). Section 6051(a) requires employers to
report on IRS Forms (W-2) as wages subject to income tax withhold-
ing and Federal Insurance Contributions Act (FICA) withholding
only the tips actually reported to them by their employees pursuant
to section 6053 (a).
Section 6041 (a) requires every employer of an employee earning
$600 or more yearly to report the total of that employee's earnings to
the IRS. As a result, the regulations (sec. 1.6041-2(a) (1)) specify
that earnings in addition to those required to be reported as subject to
withholding are required to be reported separately to the IRS on the
Form W-2 for the employee. As stated above, Revenue Ruling 76-231
has recently held that this means that charge account tips not reported
to the employer by the employee must nevertheless'be reported to the
IRS by the employer. If, because of tip-splitting or tip pooling, the
amount reported by the employee on his income tax return differs from
the total amount of tips reported by the employer for that employee,
the employee is required by the ruling to attach an explanation of the
difference to his income tax return.
Issue
Whether employers should be required to use their records to report
to the Internal Revenue Service charge account tips which are not re-
ported to the employers by their employees.
Explanation of provision
This provision was presented by Senator Fannin. It specifies that
the only employer tips which an employer must report are the tips
reported to the employer by the employee under present law (sec.
6053 (a)). Accordingly, employers would not be required by law to
keep accounts of employees' charge ticket tips or to report those tips
to.the IRS even if some of those ti)s are not reported to the employer
by the employee. This clarification is accomplished through an amend-
ment to section 6051 (d) of the Code.
Thle provision also clarifies the employer's record-keeping require-
ments. Section 6001 is amended to provide that the only records an
employer must keep in connection with charge tips are charge receipts





41


and copies of tip reporting statements furnished to employers by em-
ployees pursuant to section 6053 (a). Thus, employers would not be re-
quired to maintain running tabulations of the allocation of total
charge account tips to particular employees.
This provision applies to all restaurant employees and is also a
matter of concern to both owners of restaurants and to those who issue
credit cards.
31. Qualification of Fishing Organizations as Tax-Exempt Agri-
cultural Organizations (sec. 1314 of the bill)
Present law
Agricultural organizations are exempt from tax under section 501
(c) (5) of the Code. Organizations devoted to promoting or improving
fisiniiir or such related occupations as taking lobster or shrimp are not
treated as agricultural organizations by the Internal Revenue Service.
Howe- ei,, orQ'anizat ions devoted to promoting or improving fishing
1',l related pursuits may qualify for tax exemption under section 501
(c) (6) as business leagues.
I.sse
Whether organizations or leagues devoted to fishing and related
pursuits should be exempted from Federal income taxation as agricul-
tural organizations in the sense of section 501 (c) (5) of the code.
E.rpl7 ot'nafion of provision
This provision was presented by Senator Hathaway. It clarifies
the meaning of "agricultural" in section 501 (c) (5) and provides that
"agricultural" includes (but is not necessarily limited to) the art or
science of cultivating land, harvesting crops or aquatic resources, or
raising livestock.
The term "harvesting * aquatic resources" includes fishing and
related pursuits (such as the taking of lobsters and shrimp). Both
fresh water and salt water occupations are to qualify as "agricultural"
under the new definition. In addition, the cultivation of underwater
verertation, such as edible sea plants, qualifies as agricultural in nature.
as does the cultivation or growth of any edible organism. Also, the
opera t ion of "fish farms" is to be considered agriculture under the new
definition. However, aquatic resources are only to include animal or
vegetable life, not mineral resources.
This provision is sought by fishing organizations in order to obtain
the lower postal rates which exempt agricultural organizations receive.
35. Limitation on Percentage Depletion for Oil and Gas Wells
(sec. 1317 of the bill)
Prs'(.,t law
Prior to the Tax Reduction Act of 1975 any taxpayer was entitled
to a deduction for the greater of the percentage, depletion allowance
on gross income from aii oil and g'as property or the cost depletion
allowance. The percentage 'e depletion allowance was equal to 22 per-
cent of such gro.,s income, but not more than 50 percent of the taxable
income from such property.
The Tax Reduction Act of 1975 repealed the percentage depletion
allowance for oil and gas with certain exceptions. Under the principle
exception (the "small producer exemption"), percentage depletion is






42


allowed for a limited amount of production from wells located within
the United States. The amount of production eligible for percentage
depletion is an average of 2000 barrels per day (or its equivalent in
cubic feet of gas) for 1975 and phases down to an average of 1000
barrels per day (or its equivalent in cubic feet of gas) for 1980 and
thereafter. The percentage depletion rate for eligible production re-
mains at 22 percent through 1980 and then is gradually reduced an-
nually to 15 percent for 1984 and years thereafter.
For any taxpayer eligible for the small producer exemption, the
deduction for any year attributable to such small producer exemption
may not exceed 65 percent of the taxpayer's taxable income. However.
if a taxpayer acquired an interest in an oil and gas property after 1974
and the property is "proven" at the time of transfer, the taxpayer is
generally not allowed percentage depletion on production from that
property under the small producer exemption. Also, a taxpayer is not
eligible for the small producer exemption on any oil or gas production
during any period for which such taxpayer is classified as a "retailer"
of oil or gas, or products derived from oil or gas. Finally, a taxpayer is
ineligible for the small producer exemption for any taxable year for
which the taxpayer (or a related person) engages in refining of crude
oil if, on any day during the year, he has refinery runs exceeding
50,000 barrels.
Issues
The changes in depletion rules made by the Tax Reduction Act of
1975 created certain possible problems involving the definition of re-
tailers, the application of these rules to trusts, and certain other tech-
nical respects.
Three problems have arisen with respect to the retailers exclusion.
First, present law could be interpreted to require that any person who
sells any petroleum product (for example, selling household lubricat-
ing oil in a corner hardware) would be classified as a retailer of petro-
leum products and thus precluded from obtaining any percentage de-
pletion. In addition, the definition of retailer could be interpreted
to include direct sales by natural gas producers to utilities or indus-
trial users. These sales, which in at least some cases are being encour-
aged by the Federal Power Commission, would be hampered by the
impact of the loss of percentage depletion if they were considered to
be retail sales. Third, the retailers exclusion as presently drafted can
deny percentage depletion to a U.S. oil producer who happens to have
retail outlets in foreign countries, even though those retail outlets in
no way utilize the production of the taxpayer (or of any other U.S.
producer).
In applying the new depletion rules to trusts, present law can op-
erate to deny percentage depletion to either the trust or the beneficiary
because of a mechanical defect in the method by which the 65 percent
of taxable income limitation is applied to trusts. Further, a nrobleni
arises in applying the transfer rules to trusts in that the addition or
deletion of a beneficiary can be treated as a transfer (and thus can
result in the loss of percentage depletion) even thoiu.o-h the chanCre in
beneficiaries results from birth, death, or adoption of members of the
same family.
Finally, the Treasury Department has brought to the attention of
the committee certain technical problems in the new depletion rules
which the committee agreed could best be corrected by legislation.






43


Explanation of provisions
This provision was presented by Senator Dole. The provision makes
three changes in the retailer exclusion. If, in the case of any taxpayer,
gross receipts from the sale of oil or gas, or products derived there-
from, by all retail outlets of the taxpayer (and related persons) do
not exceed $5 million for the taxable year, such taxpayer will not be
treated as a retailer for that year. In addition, the retailers exemption
is not to apply to direct bulk sales or natural gas to industrial users or
utilities. Also, a taxpayer will not be subject to the retailer exclusion
for any taxable year for which all retail sales of oil, gas, or their
derivative products by retail outlets are made outside the United
States, provided that no domestic production of the taxpayer or a
related person is exported during the year in question or in the imme-
diately preceding taxable year.
The provisions add an exception to the transfer rule so that a change
of beneficiaries of a trust is not considered a "transfer" if the change
occurs solely by reason of the death, birth, or adoption of any bene-
ficiary in cases where the transferee was a beneficiary under the trust
prior to the triggering event or is a lineal descendant of the grantor
or any other beneficiary.
Under present law, in cases where income distributions are made
to beneficiaries, such distributions reduce the thixable income of the
trust and, because of the 65-percent of taxable income limitation,
reduce or eliminate the deduction under the small producer exemption.
Since beneficiaries to whom Some depletion deduction is allocated can
only receive the deduction to the extent it is first obtainable at the
trust level this rule can result in no percentage depletion deduction
for either the trust or any beneficiary. To correct this situation, the
provision adds that, for purposes of the 65-percent-of-taxable-income
limitation, a trust's taxable income shall be computed without a de-
duction for distributions to beneficiaries during the taxable year.
* The provision 'also adds technical amendments suggested by Tre.s-
ury. These amendments disregard any tentative percentage depletion
deduction itself in computing the 65 percent of net income limitation,
clarify the participation rules for apportioning basis in an oil and
gas property among the partners, and tighten the rules defining
related persons and entities for purposes of the retailers' and refiners'
exclusions from the small producers exemption.
These provisions are effective for taxable years beginning after
December 31, 1974 (the effective date of the provisions relating to
the percentage depletion deduction in the Tax Reduction Act of 1975).
The $5 million de minimis rule will be of benefit to many producers
who have small retail outlets. The provision relating to retail outlets
outside the U.S. will be of benefit to Belco Petroleum Corporation. The
trust provisions will be of benefit to trusts holding oil properties which
do not use cost depletion.
Revenue effect
The provisions will reduce budget receipts by $18 million in fiscal
year 1977, $10 million in fiscal year 1978, and $10 million in fiscal
year 1981. All but a negligible amount of this revenue loss is attributa-
ble to the changes proposed in the retailer exclusions.


74-375-76- 4





44


36. Simultaneous Liquidation of Parent and Subsidiary Corpo-
rations (sec. 1320 of the bill)
Present l7a w
Under present law, a corporation which adopts a plan of complete
liquidation and, within 12 months thereafter, sells or exchanges some
or all of its assets and liquidates completely generally does not recog-
nize gain or loss from the sale or exchange (sec. 337). The receiving
shareholders will ordinarily be taxable on the sale proceeds (sec. 331).
This corporate nonrecognition rule does not apply, however, if the
corporation making the sale or exchange is an 80 percent or greater
controlled subsidiary of a parent corporation and if the parent. takes
a carryover basis in the assets of the subsidiary when it liquidates the
subsidiary (sec. 337 (c) (2)). If a corporate shareholder of a company
which sells its assets is not taxable when it liquidates the subsidiary
(as occurs under sec. 332), and if the subsidiary were not taxable on a
gain from selling its assets, no tax at all would be paid on the gain
represented by the sale proceeds.
In some situations, where both the parent and the subsidiary plan
to liquidate after a sale of property by the subsidiray it is less im-
portant to tax the subsidiary on its gain from a sale of assets. In fact,
a sale of assets by the subsidiary will be subject to tax under section
337(c) (2) and the shareholders of the parent corporation will also
recognize gain when the parent liquidates. The Internal Revenue
Service has held that this tax result can be avoided under present law
if the parent first liquidates the subsidiary into itself (without recog-
nizing gain or loss by reason of sec. 332) after which the parent adopts
its own plan of liquidation (under sec. 337) and sells the assets for-
merly owned by the subsidiary. Under that sequence, neither the parent
nor its subsidiary would recognize gain or loss and the parent's share-
holders would recognize gain or loss on the liquidation of the parent.1
Issue
The issue is whether, consistent, with the underlying purpose of
section 337, the sequence of formal steps taken by the parties in this
type of situation should determine what tax results occur.
Expla nation of provisoiw?
This provision was suggested by Senator Hansen. The provision
permits the general nonrecognition rule of section 337 (a) to apply
to a controlled subsidiary which sells property and then liquidates
completely, provided that the parent corporation also liquidates com-
pletely in the same transaction. In order to obtain non-recognition of
gain.or loss, all otiler generally applicable requirements of section 337
would have to be satisfied (such as the rule that the sale of exchange
of property must occur within 12 months after the subsidiary adopts
n pla n of complete liquidation).
The amendment requires, however, that in this situation not only
must the selling subsidiary make a liquidating distribution of all of its
remaining assets (less assets retained to meet claims) within 12 months
after its plan of liquidation is adopted, but, in addition, during the
same 12 month period, the parent corporation must also distribute all
of its as sets in its own complete liquidation.
SSee Rev. Rul. 69-172. 1969-1 Cum. Bull. D9.






45


If the selling subsidiary is a member of a group of controlled sub-
sidiaries having a common parent corporation, the amendment re-
quires in effect that all other subsidiaries in the direct line of stock
ownership above the level of the selling subsidiary must also liquidate
completely.
This provision is effective for sales or exchanges made pursuant to
a plan of liquidation adopted on or after January 1, 1976.
This provision has been recommended by the American Bar Associa-
tion. It is believed to have general application.
37. Prohibition of State-Local Taxation of Vessels Using Inland
Waterways (sec. 1321 of the bill)
Present lah
Although Congress has the power to regulate interstate commerce,
few Federal limitations upon the power of States to tax transactions
in interstate commerce have been enacted. Public Law 86-272 1, how-
ever, placed certain minimum standards upon the power of States to
tax nondomiciliaries selling in the taxing State.
Congress has also done little to limit the power of States to tax com-
mon carriers in interstate commerce. However, Public Law 94-210,2
the Railroad Revitalization and Regulatory Reform Act of 1976, does
prevent States from taxing railroads at rates higher than those placed
on other commercial property. Congress has not limited the power of
States to tax vessels using navigable waterways.
Issue
The issue is whether a State or a political subdivision of a State
having no "nexus"' with a barge engaged in interstate commerce on
navigable waters should be allowed to tax that barge.
Explanation of provision
This provision was included by the Committee at the suggest ion of
Senator Eastland. The provision prohibits any State or political sub-
division of a State from taxing any vessel (or barge or other craft)
using the navigable waters of the United States in interstate com-
merce. For the purposes of this limitation, it is understood that
the term "interstate commerce" is to include not only the actual carry-
ing of passengers or goods for hire, but also is to encompass return
trips to the home port when the vessel may be carrying no passengers
or cargo, trips to a port to bring on passengers or cargo, trips for
the purpose of repair, and such other uses of navigable waters which
case law or statutory law has deemed to be included in the term "inter-
state commerce."
This provision is not intended to limit the traditional taxing juris-
dictions specifically recognized in the amendment. Therefore, this
prohibition of local or State taxation is not to apply to any State or
political subdivision of a State in which the craft is incorporated. The
prohibition does not apply to taxation of any craft owned by an indi-
vidual, partnership, or corporation which is domiciled in, or is a resi-
dent of, the State imposing the tax, or the State in which the political
subdivision imposing the tax is situated. Finally, the provision does
not apply to any tax of a State or political subdivision of a State in
1 '6th Cong., 1st SPsS.. 73 Stat. 55., (1959).
2 94th Cong.. 2d'Sess., 90 Stat. 31 (1976).






46


which the craft has its home port. ("Home port" is to refer to the
principal place of business use of the craft.)
This provision will benefit barge operators on the Mississippi River.
It will also benefit those on other rivers as well.
38. Contributions to Capital of Regulated Public Utilities in Aid
of Construction (sec. 1322 of the bill)
Present law
Under present law, contributions to the capital of a corporation,
whether or not contributed by a shareholder, are not includible in the
gross income of the corporation (sec. 118). Nonshareholder contribu-
tions of property to the capital of a corporation take a zero basis in the
hands of the corporation. If money is contributed by a nonshareholder,
the basis of any property acquired with such money during the 12-
month period beginning on the day the contribution is received or of
certain other property is reduced by the amount of such contribution
(sec. 362 (c)).
Certain regulated public utilities (water and sewage disposal) have
traditionally obtained a substantial portion of their capital needed for
the construction of facilities through contributions in aid of construc-
tion. The concept of contributions in aid of construction originates
from a line of early Board of Tax Appeals decisions dealing with
amounts contributed by customers to public utilities to pay for exten-
sions of service lines necessary to enable them to be serviced by the
public utility. The decisions treated such amounts as not giving rise to
taxable income to the public utilities.
In 1975, the Service issued Revenue Ruling 75-557, 1975-2 C.B. 33,
which withdrew the IRS's acquiescence in the early line of cases and
held that amounts paid by the purchaser of a home in a new sub)divi-
sion as a connection fee to obtain water service are includible in the
utility's income. The current ruling is made prospective for trans-
actions entered into on or after February 1, 1976.
Issue
The issue is whether contributions in aid of construction to a water
or sewage disposal utility should be treated as contributions to capital
or as payments received for services rendered.
Explanation of provision
This provision was suggested by Senator Gravel. It amends the
current rules concerninff nonshareholder contributions to capital by
specifying that amounts received as contributions in aid of construc-
tion by a water or sewage disposal utility (described in section 7701
(a) (33) (A) (i)) which are used for qualified expenditures and which
are not included in the rate base for rnte making purposes by the regu-
latory body having rate-making jurisdiction will be treated as non-
taxTble contributions to the capital of the utility.
For this purpose, the Secretary is to prescribe rules defining what
items and amounts constitute a contribution in aid of construction.
The following are examples of facilities which the committee con-
siders to be contributions in aid of cost riiucetion:
(1) A builder or developer constructs water lines and/or support
facilities such as water filtration plants, water towers, etc.. and turns
such facilities over to a regulated water or sewage disposal utility.





47


(2) A builder or developer furnishes the necessary funds to a regu-
lated water or sewage disposal utility which uses those funds to build
certain water or sewage disposal facilities.
(3) A builder or developer pays for the water or sewage disposal
facility (commonly referred to as an "advance") in return for the
qualifying utility agreeing to pay the developer a percentage of the
receipts from the facilities over a fixed period. Where the total pay-
ments made to the developer are less than the cost of the facilities
which are transferred to the utility, any difference is to be treated as
a contribution in aid of construction.
(4) A customer pays a fee to reimburse the utility for lines, valves,
pipes, or meters, or a customer constructs his own lines which are
turned over to the water or sewage disposal utility.
(5) Governmental units furnish regulated water or sewage disposal
utilities with relocation fee payments where the local jurisdiction re-
quires that certain construction be done by the utility in order to
achieve a desired purpose of the government unit, e.g., tearing up anl
old road to be replaced by a new one may require replacement of cer-
tain underground pipes and lines, providing additional sewage dis-
posal facilities as a result of drainage projects, etc.
A qualified expenditure is an amount which is expended for the
acquisition or construction of tangible capital assets,1 where the ac-
quisition or construction of the facility was the purpose motivating
the contribution (i.e., the purpose for which such amounts were
collected).
This provision will be of general benefit to sewer and water
companies.
Revenue effect
This provision will reduce budget receipts by $13 million in fiscal
yea r 1977, $11 million in fiscal year 1978, and $11 million in fiscal year
1981.
39. Prohibition of Discriminatory State Taxes on Generation of
Electricity (sec. 1323 of the bill)
Present law
Federal statutes provide few limitations on the power of States to
tax nondomiciliaries or to impose special taxes on goods or services
produced in the taxing State for nondomiciliary use outside the taxing
State.
However, Public Law 86-272 2 does establish certain minimum stand-
ards upon the power of a State to tax nondomiciliaries selling in the
taxing State in interstate commerce. That Act did not affect the powers
of States to tax goods or services produced within its boundaries for
consumption outside its boundaries. Title II of the Act, however, also
provided for further "studies of all matters pertaining to the taxation
of interstate commerce...."
Issue
Whether Congress should exercise its constitutional power to regu-
late interstate commerce by forbidding States to place discriminatory
I For( this purpose. a capital asset inediips all expenditures which must be capitalized
for such facilities under the normal rules of tax accounting (see. 263).
2 86th Cong., 1st Sess., 73 Stat. 555 (1959).





48


taxes upon the generation or transmission of electricity within the
taxing State for consumption outside its boundaries.
Explanation of provision .
This provision was suggested by Senator Fannin. The provision
prohibits any State, or political subdivision of a State. from imposing
a tax on or with respect to the generation or transminission of electricity
in interstate commerce if the tax is discriminatory against out-of-state
manufacturers, producers, wholesalers, retailers, or consumers of that
electricity. A tax is considered discriminatory if it directly or in-
directly results a greater tax burden on electricity generated and trans-
mitted in interstate commerce than on electricity which is generated
and transmitted in intrastate commerce.
This provision is not intended to prohibit, restrain, or burden any
other State which currently imposes a nondiscriminatory tax on the
generation or transmission of electricity.
This provision replaces the current Title II of Public LIaw 86-272.
,which is the title calling for further congressional studies. A number
of studies of the problem of multistate taxation of interstate commerce
have already been made by congressional committees. and the present
Title II is not required to authorize any additional studies that may be
needed.
This provision will be of benefit to Arizona residents whose electric-
ity is generated in New Mexico. It may have application elsewhere.
40. Tax-Exempt Annuity Contracts in Closed-End Mutual Funds
(sec. 1505 of the bill)
Present 1(1W
Under present law, amounts contributed by certain tax-exempt em-
ployers for the purchase of an annuity contract (a tax-sheltered
annuity) for an employee are (within limits) excluded from the gross
income of the employee (sec. 403(b)). The tax-exempt employers to
which this provision relates for the most part are religious, charitable
and educational organizations and educational institutions operated
by a State or local government.
Under a provision added to the Code by the Employee Retirement
Income Security Act of 1974 (ERISA), amounts contributed by an
employer for the purchase of stock of a regulated investment com-
pany which issues redeemable shares (an open-end mutual fund) in
order to provide a retirement benefit for an employee are treated as
amounts paid for the purchase of a tax sheltered annuity (sec. 403
1(b) (7). However, amounts contributed by an employer for the pur-
chase of stock in a regulated investment company which does not issue
redeemable shares (a closed-end investment company) do not qualify
for treatment as amounts paid for the purchase of a tax sheltered
annuity.
Issue
The issue is whether amounts contributed by an employer for the
purchase of stock in a regulated investment company which does not
issue redeemable shares (a closed-end investment company) should
qualify for treatment as amounts paid for the purchase of tax-sheltered
annuities under the same circumstances as amounts contributed for
the purchase of shares of an open-end mutual fund.







Explanation of provision
This provision was sponsored by Senator Bentsen. The provision
permits an investment in stock of a closed-end investment company
to qualify for treatment as a tax-sheltered annuity by depleting the
provision in present law that limits qualifying investments in regu-
lated investment companies o investments in those which only issue
redeemable stock.
This provision would apply to taxable years beginning after Decem-
ber 31,1975.
This provision will be of general benefit to closed-end mutual funds.
41. Pension Fund Investments in Segregated Assets Accounts of
Life Insurance Companies (sec. 1506 of the bill)
Prce..iet law
Under present law, a life insurance company may base its reserve
for certain annuity contracts (e.g., variable annuity contracts) on a
segregated ass-et account. Accordingly the amounts paid in or paid out
under the contract vary with the performance of the assets held under
the account. Under the Code, the income, expenses, gains, and losses
with respect to assets held under a segreg-ated asset account under a
contract for a qualified pension plan are generally not considered in-
come, etc. of the life insurance company.
Under present law, a segregated asset account may not be used bv
a life insurance company except as the basis for a contract which
provides for the payment of annuities. The Internal Revenue Service
has taken the position that a segregated asset account can be ius-d as
the basis for a reserve for a contract by a particular life insurance
company only if that life insurance company provides annuities under
the contract. Therefore, an employer who wishes to have its qualified
pension fund invested in a segregated asset account held by a par-
ticular life insurance company but wishes to purchase annuities. from
another life insurance company (or to provide annuity benefits direct-
ly from an employee trust) is unable to do so without incurring the
cost of compensating the holder of the account for annuity purchase
rate guarantees that will not be utilized.
Issue
The issue is whether the law should be changed to permit segregated
asset accounts to be used as reserves for contracts which do not provide
for annuities.
Explanation of provision
This provision was included at the suggestion of Senator Bentsen.
The provision clarifies present law by providing that a segregated
asset account can be used as an investment medium for assets of a qual-
ified pension, profit-sharing, or anuity plan even though the account
is held as a reserve under a contract which does not require the holder
of the account to provide for the payment of annuities. The provision
also permits assets of a qualified plan to beheld in a segregated account
instead of a trust. The provision does not in any way modify the re-
quirements of title I of the Employee Retirement Income Security Act
which requires certain pension plan assets to be held in a trust.
The provision applies for taxable years beginning after Decem-
ber 31, 1975.





50


This provision will be of benefit to life insurance companies having
annuity contracts (for example, variable annuities) handled on a seg-
regated asset account basis.
42. Extension of Study of Salary Reduction and Cash or Deferred
Profit-Sharing Plans (sec. 1507 of the bill)
Present law
Under present law, in general, an employee's contributions to a tax
qualified retirement plan maintained by his employer are not tax de-
ductible. In the case of a salary reduction plan, or a cash and deferred
profit-sharing plan, however, the Internal Revenue Service has per-
initted employees to exclude from income certain amounts contributed
by their employers to the plan, even where the source of these amounts
is the employee's agreement to take salary or bonus reductions, or fore-
go salary increases.
On December 6, 1972, the Service issued proposed regulations which
would have changed this result in the case of salary reduction plans,
and which called into question the continued viability of the treatment
of cash and deferred profit-sharing plans.
In order to allow time for congressional study of these areas, sec-
tion 2006 of the Employee Retirement Income Security Act of 1974
(ERISA) provided for a temporary freeze of the status quo. Under
ERISA, contributions to plans in existence on June 27, 1974, are gov-
erned under the law as it was applied prior to January 1, 1972. and this
treatment is to continue at least through December 31, 1976, or (if
later) until regulations are issued in final form in this area, which
would change the pre-1972 administration of the law. Section 2006 of
ERISA provides that these regulations, if issued, are not to be retro-
active for purposes of the social security taxes or the Federal with-
holding taxes, and are not to be retroactive prior to January 1, 1977,
for Federal income tax purposes.
In the case of plans not in existence on June 27; 1974, contributions
made on a salary reduction basis, or made, at the employee's option, to
a cash and deferred profit-sharing plan, are treated as employee con-
tributions (until January 1, 1977. or until new regulations are pre-
scribed in this area). This was intended to prevent a situation where a
new plan might begin in reliance on pre-1972 law while Congress has
not yet determined what the law should be in the future.
Also to be covered under these principles are so-called "cafeteria
plans," under which the employees may have a choice. between certain
fringe benefits, some of which would constitute taxable income to the
employee, whereas other forms of benefit might not. Thus. cafeteria
plans in existence on June 27, 1974, also are governed under the pre-
1972 law until at least January 1, 1977. However, in the case of new
plnms. the value of any benefits selected under a cafeteria plan are
to be includable in income until at least January 1, 1977 (or. if later,
until new regulations in this area have been promulgated). In general,
the sfime rules to be applied in dcleterminin whether or not a salary
reduction plan was in existence on June 27, 1974, are also to be applied
to cafeteria plans. Of course, minor plan amendments (such as chang-
ino the plan to allow cash payments to cover cases of breakage, i.e..
where two alternative benefits available under the cafeteria plan do not
have exactly the same value) would not cause an existing plan to be
classified as a new plan for purposes of these rules.








Issue
The issue is whether the temporary freeze of the status quo provided
for in section 2006 of ERISA should be extended beyond January 1,
1977, to allow additional time for Congress to study the questions in-
volved in order to enact permanent legislation regarding salary reduc-
tion and cash and deferred profit-sharing plans.
Explanation of provision
This provision was suggested by Senator Brock. In order to allow
additional time for congressional study of these areas, the provision
extends the temporary freeze from January 1, 1977, until January 1,
1979.
This provision will be of benefit to Eastman Kodak Company. Irv-
ing Trust Bank, Xerox, TRW, and others.
43. Consolidated Returns for Life and Mutual Insurance Com-
panies (sec. 1508 of the bill)
Present law
Under present law, life insurance companies, both stock and mu-
tual, (taxed under section 802 of the code and hereafter referred to as
life companies) are barred from filing consolidated income tax returns
with corporations that are not life companies. A similar restriction
applies to mutual insurance companies other than life companies
(taxed under section 821 of the code and hereafter referred to as
"other mutual insurance companies). On the other hand, stock prop-
erty-liability insurance companies (and certain other companies) taxed
under section 831 of the code are generally permitted to file consoli-
dated returns with other types of corporations.
Issue
The issue is whether stock and mutual life companies and other
mutual insurers should be allowed to file consolidated returns with
other corporations.
Explanation of provision
This provision was suggested by Senator Ribicoff. It permits con-
solidated returns to be filed by stock or mutual life insurance compa-
nies (or other mutual insurers) and nonlife companies, subject to
the restrictions that (1) the life company's taxable income cannot
be reduced by more than one-half as a result of the consolidation,
and (2) no more than one-half of a nonlife company's losses can
be applied against a life company's income in any year. Any
nonlife company losses not absorbed in this manner will still be avail-
able as carryovers of the nonlife companies to subsequent years. The
filing of a consolidated return by an affiliated group which includes a
life company and a property-liability company will permit the tax
savings from the property-liability company's losses to be taken into
account sooner in computing its statutory surplus. This larger surplus
should increase the capacity of these companies to write insurance.
The provision is effective for taxable years beginning after Decenm-
ber 31, 1977. However, a transitional rule is provided to'limit the use of
carryovers of losses and credits for pre-1978 years. These carryovers
are to be treated as if the committee amendment had not been made.
This means that the ability to absorb these losses or credits is not to be
changed as a result of the new election to include life or other mutual





52


insurance companies in a consolidated return with other companies.
The same principles also apply with respect to losses and credits which
may be carried back to pre-1978 years.
This provision will be of benefit to life insurance companies which
own casualty companies that incur losses.
Revenue effect
It is estimated that this provision will result in a decrease in reve-
nues of $25 million in the fiscal year 1978, $55 million in the fiscal year
1979, $49 million in the fiscal year 1980, and $40 million in the fiscal
year 1981.
44. Modifications in Investment Credit for Railroads (sec. 1701
of the bill)
a. Percentage Limitation on Credit
Peeseit law
The amount of investment tax credit which can be taken in any one
year may not exceed the first $25,000 of tax liability plus 50 percent of
the liability greater than $25,000. In the Tax Reduction Act of 1975,
the 50-percent limit was increased temporarily for public utility prop-
erty to 100 percent for 1975 and 1976, 90 percent for 1977, 80 percent
for 1978,70 percent for 1979,60 percent for 1980 and back to 50 percent
for 1981 and later years..
Is8s te,
The generally low profit rates of railroads in recent years mean that
thie 50-percent limit of tax liability cannot accommodate investment
credits earned under substantially expanded investment programs
initiated by railroads since 1973. Without an adjustment of the kind
made available to public utility property, railroads would accumulate
sul)stantial carryforwards which might be lost in the future when the
carryforward period for the credit terminates.
The issue is whether railroads are similar enough to public utilities
to receive the same treatment with respect to the 50-percent limit.
Explanation of provision
This provision was sponsored by Senator Hartke. Under this pro-
vision, railroads would be allowed to apply investment credits against
100 percent of tax liability in 1977 and 1978, 90 percent in 1979, 80 per-
cent in 1980, 70 percent in 1981, 60 percent in 1982, and 50 percent in
1983 a n d later years.
The provision applies for taxable years ending after December 31,
1976.
The provision would benefit all railroads which would be operating
at a low (or zero) profit margin for the next few years. The Associa-
tion of American Railroads expressed an interest in this provision.
Revenue effect
Budget receipts would be reduced by this provision by $29 million in
fiscal year 1977, $66 million in 1978 and $41 million in 1981.
b. First-in-First Out Treatment of Investment Credit
Present law
Investment tax credits earned currently are applied to the current
year's tax liability before any carryforwards may be used. Unused
credits expire at the end of the carryforward period.





53


Issue
Railroad companies would lose between $50 million and $80 million
from 1978 through 1982 in carryforwards of expiring unused invest-
ment credits that have been carryforwards from earlier taxable years.
The 50-percent limit and low taxable income did not permit full use of
the credits currently.
The issues are whether the sequeiince prescribed for using investment
credits should be changed and whether the change should apply to only
the railroads.
Explanation of provision
This provision was suggested by Senator Curtis. The provision
would permit railroads to apply carryforwards of the investment
credit earned in prior years to the current year's tax liability before
applying investment credits earned in the current year.
The provision applies to computations in taxable years ending after
December 31,1976.
This provision would benefit railroads generally which have unu-ed
carryforlwards in the years after 1976 and who make additional in-
vestments in tho'e years. The Association of American Railroads ex-
pressed ani interest in this provision.
Revenue effect
The revenue loss from this provision is estimated as negligible duir-
ing fiscal years 1977, 1978 and 1981 because the investineiit credits are
fully utilized.
45. Amortization of Railroad Assets (sees. 1701 and 1702 of the
bill)
a. Amortization of grading and tunnel bores
Present law
Railroads may elect to amortize, on a straight-line basis over a
5-year period, railroad(l grading and tunnel bores placed in service after
1968.
Issue
Before 1969, tax law followed ICC practice of not permitting
depreciation of tangible railroad property that has an indeterminate
useful life. In 1969, Congress enacted the present law provision for
such property placed in service prospectively. In recent years, several
railroads have entered into litigation to establish useful lives for
depreciation purposes. Fifty-year amortization has been established
since 1969 as a means to permit the taxpayer to recoup the costs of
these investments in relatively small annual changes.
The issue is whether 50-year, straight-line amortization should be
-extended to grading and tunnel bores placed in service before 1969.
Explanation of provision
This provision was included in the House-passed bill. Under the
provision, a railroad would be allowed to elect to amortize railroad
grading and tunnel bores that were placed in service before 1969 on a
straightline basis over a 50-year period. Property valuations for acqui-
sitions or construction since 1913 have been established by the ICC or a
State regulatory commission, and where valuation disputes have not
been resolved, the basis for determination of capital gain or loss for
Federal tax purposes may be used as the basis for amortization.






54


The provision is to apply for taxable years beginningafter Decem-
ber 31,1974.
This provision would be of benefit generally to all railroads.
Revenue effect
Budget receipts would be. decreased by this provision by $21 million
in fiscal year 1977 and $18 million in each subsequent fiscal year.
b. Treatment of certain railroad ties
Present law
When new ties are laid, the costs for materials and labor are capital-
ized, and no depreciation is claimed on the original installation. On
replacement of the original equipment with track or ties of a like kind
or quality, for example, new wood ties for old wood ties. the replace-
ment costs are deducted as current expense. When the replacement is a
like kind but improved quality, it is treated as a betterment, under
which the betterment cost is capitalized and the remainder is expensed.
This would be the case of wood ties capable of carrying heavier loads.
Retirement and substitution involves replacement with a different
kind of tie, concrete, for example, and the costs of the. new ties are
capitalized and the old ones are deducted as current expense.
Issue
Two railroads have been replacing wood ties with concrete ties.
Under the present regulations, the costs of the retired ties would be
deducted from the capital account and deducted as a current expense.
The costs of the new ties would then be added to the capital account.
This is consistent with the retirement-substitution approach. The com-
mittee amendment provides a variation of the betterment approach
under which the taxpayer may take a current deduction equal to the
current market value of the kind of ties to be replaced, and the remain-
der would be capitalized. In the House bill, the entire cost of a different
or improved type of railroad tie would be deducted currently.
In addition, section 1701(b) of the committee bill would permit a
railroad to elect 10-year, straight-line amortization for costs in their
track accounts (which include ties) that are capitalized under the
retirement-replacement method.
The issue is whether the costs of concrete ties should be allowed
as an item of current expense and fully deducted in the year they are
incurred or whether concrete ties should be treated under the same
regulations and code provisions as are all other railroad ties.
Explanation of provision.
This provision is a modification which tightens up the House-passed
bill. Under the provision expenditures for acquiring and installing
nonwood railroad ties may be deducted as a current expense equal to
the fair market value of replacement wood ties and the remaining cost
is to be charged to the capital account.
The provision applies to amounts paid or incurred in taxable years
beginning after December 31,1975.
This provision would benefit the Black Mesa and Lake Powell Rail-
road a n d the Florida East Co a st Railway.
Revenve effect
Budget receipts would be reduced by less than $5 million a year
by this provision.





55


c. Amortization of railroad track assets
Present law
When new rails and ties are laid, the costs of these and other mate-
rials in the track account and labor are capitalized, and no deprecia-
tion is claimed on the original installation. On replacement of the
original replacement with track or ties of a like kind or quality, e.g.,
new wood ties for old wood ties, the replacement costs are deducted as
current expense. When the replacement is a like kind but improved
quality, it is treated as a betterment, under which the betterment cost
is capitalized and the remainder is expensed. This would be the case
of rails or wood ties capable of carrying heavier loads. The replace-
ment-retirement method of depreciation and other forms of deprecia-
tion are mutually exclusive. As a result, if a railroad uses retirement
replacement method for track account replacements, it cannot depre-
ciate the original capital costs without consent of the Commissioner of
the Internal Revenue Service.
Issue
The condition of U.S. railroad track had been allowed to deteriorate
seriously, and the expenses of restoring them to satisfactory operating
conditions are substantial. In addition, old tracks are being replaced
with equipment able to sustain heavier freight cars and loads. Current
accounting methods require capitalization of the costs incurred but do
not permit any depreciation of the costs. When the item is replaced,
the initial costs are expensed currently, and the costs of the repalcement
are added to the capital account. This system reflects a belief that
useful lives of assets in the track accounts are too indeterminate to
warrant depreciation over a finite period.
The issues are whether assets in the track accounts should be treated
as though they had determinate useful lives and how long a period
should be allowed for their depreciation.
Explanation of pro6'.qion
The provision establishes straight-line, 10-year amortization of as-
sets in the track accounts (numbers 8, 9. 10, 11 and 12 in the ICC
Uniform System of Accounts for Railroads).
This provision would apply to track account assets placed in service
in taxable vealrs that begin after December 31, 1975.
The provision would apply generally to all railroads.
Revenue effect
Bud(-et receipts would be reduced by $4 million in fiscal year 1977,
$10 million in fiscal year 1978 and $28 million in fiscal year 1981.
46. Residential Insulation Credit (sec. 2001 of the bill)
Present Jaw
Under present law, no special credit or deduction is allowed for ex-
penditures for insulation (including installation of a clock thermostat)
of a taxpayer's own residence.1
1 However, if the expenditures are undertaken in connection with the sale of the resi-
dence, then it has been held that those expenditures might be deduictihble under section 212
of the Code as being incurred in connection with the production of income. Also, if the
insulation is of such a magnitude as to be an improvement in the house, then the expendi-
tures may constitute additions to the taxpayer's basis in the house.






56


Is88sue
Whether the refundable tax credit provided in thie committee's bill
for installation of insulation upon a residence should be extended to
include expenditures for a clock thermostat.
ExplanatIon of provision
This provision was originally agreed to by the Finance Conmmittee
in July, 1975, as part of its consideration of the energy bill (H.R.
6860). The provision allows a refundable tax credit for 30 percent of
the first $750 (for a maximum credit of $225) spent on insulating a
residence used by the taxpayer paying for the insulation. The credit is
to be available only for installations of qualifying material and pay-
ments made before January 1, 1979, and it is also limited to installa-
tions in structures already in use or habitable as residences on May 25.
1976.
The "insulation" for which the credit is to be available is to be any
insulation, storm (or thermal) window or door, or any other similar
item specifically and primarily desi.oned to reduce the heat gain or loss
of a residence. In addition, the material, to qualify, must have an origi-
nal use commencing with the taxpayer, a useful life of at least 3 years,
and it must meet criteria and standards to be prescribed by adminis-
trative officials.
The provision specifically includes clock thermniostats as "any other
similar item."
The inclusion of clock thermostats as qualifying for thlie insulation
credit was done at the suggestion of Senator Mondale. Under the
House energy tax bill, H.R. 6860, the determination of whether clock
thermostats would be eligible for the insulation credit was left to the
administrative officials who were to prescribe the criteria and stand-
ards for energy-conserving equipment generally.
Including clock thermostats benefits companies which manufactutire
and sell these items, including Honeywell, Inc.
47. Residential Heat Pump Credit (sec. 2002 of the bill)
Present lt it,
Under present law, no special tax credit or deduction is allowed
for installing a heat pump in a residence.
Issues
The issues are whether a tax credit should be allowed for installa-
tion of heat pumps on residences, and, if so, for what period of time
the credit should be allowed.
SE'pl a nation of pro wsion
The provision establishes a refundable income tax credit for the
installation of heat pumps in, on, or in connection with any residential
use by the taxpayer. The amount of the credit for installation of a heat
pump is 20 percent of the first $1,000 of qualified expenditures, plus
121/2 percent of the next $6,400 (maximum credit of $1.000). To qual-
ify, the expenses must be paid by the individual (or individuals) who
is using the st ructure as a residence.
The credit is for both the expenditures for the equipment itself and
the expenditures for its installation. Expenditures for presently exist-
ing structures, but not for houses built during the credit period, will
qualify for the credit.






57


The credit may be claimed only for qualified payments during the
year or other tax period for which the tax return is filed.2
The equipment for which the credit may be claimed is that neces-
sary to permit a heat pump to function in a home. This would include
any special ducting required. "Function" in this sense, refers to the
capacity of a heat pump to heat or cool a building, to provide hot
water for it, or to perform any of the other uses normal to the heat
pump under the circumstances.
It is usually mncessary, at least at this stage of the heat pump indus-
try's technical advancement, to use heating or cooling units employ-
ing conventional energy sources as "back-ups" to the heat pump for
use or supplemental use during periods when the outdoor tempera-
ture falls below approximately 25 degrees Fahrenheit. However, the
credit is not to be available for expenditures for these back-up units.
If joint owners install a heat pump for their common residence, the
credit is to be apportioned among those who paid for the installations
in accordance with the proportion which each paid bears to the total
payment during the calendar year.
The heat pump credit is a refundable credit. As a result, a taxpayer
whose tax liability is less than the amount of the credit would receive
a refund of the difference, while the amount of his credit that equals
the amount of his tax liability would be available to eliminate that
liability.
Neither the current House bill nor the House-passed energy tax bill
provided a tax credit, or any tax incentive, for installation of a heat
pump.
This provision will benefit generally manufacturers of heat pumps.
General Electric and Westinghouse have been mentioned as manu-
facturers which were interested in this provision.
Revenue effect
It is estimated that the credit for heat pumps and their installation
will reduce revenues by $3 million in fiscal 1977, $5 million in fiscal
1978, and $6 million in fiscal 1979.
48. Investment Credits Relating to Energy Conservation and
Production (sec. 2003 of the bill)
a. Business insulation credit
Present law
Insulation of business property is included among structural com-
ponents which are not eligible for the investment credit.

Properly insulated structures will reduce heat loss in winter and
heat gain in summer and thereby contribute to greater energy
conservation.
The issue is whether a temporary tax incentive in addition to higher
fuel prices will stimulate enough additional insulation of businem-s
structures to produce significant increases in business property
insulation.
Explanation of provision
This provision extends the 10 percent investment credit to the
2 Pre-July 1, 1976, expenditures and installations are to bf ignored in d&trmiRii,
whether and to what extent the expenditures limit is reached under this provision.





58


payment or accrual of costs for insulating an existing business prop-
erty after December 31, 1976, and before January 1, 1979.
This provision was originally agreed to by the Finance Committee
in its consideration of H.R. 6860 and had been included in the House-
passed version of that bill.
Revenue effect
It has been estimated that budget receipts would be decreased by $11
million in fiscal year 1977, $26 million in 1978 and $15 million in 1979.
b. Business solar and geothermal equipment credit
Present law
Solar or geothermal energy equipment does not usually qualify for
the investment credit because this equipment is usually considered as a
structural component of a building.
Issue
Solar or geothermal energy could be used as a substitute or supple-
ment for energy produced with petroleum or natural gas, and to the
extent they are used, reliance on scarce petroleum or natural gas would
be reduced.
The issue is whether a temporary tax incentive is necessary to encour-
age a great enough interest in the use of these forms of energy to
accelerate the rate of their commercial installation.
Explanation of provision
This provision was proposed by Senator Fannin and Senator Pack-
wood.
The provision establishes a special investment credit of 20 percent
through 1981 and 10 percent through 1986 for both solar and geo-
thermal energy equipment. The credit is available for equipment which
becomes a structural component of a building and for equipment in-
stalled for lodging property.
The special investment credit would be effective at the 20-percent
rate only for property acquired, or the construction of which is com-
menced, after May 25, 1976, and before 1982, and it is effective at the
10-percent rate for property acquired, or the construction of which is
commenced, after 1981 and before 1987.
The provision generally benefits purchasers and manufacturers of
solar and geothermal equipment. Among those expressing an interest
in this provision are Union Oil Company, San Diego Gas and Electric,
Geothermal Resources International, Earth Power Corporation, Geo-
thermal Kinetics, Inc., Geosystems, Inc., and Thermal Resources, Inc.
c. Waste conversion equipment
Present law
There are no tax provisions in present law that relate specifically to
the categories of equipment that include waste conversion equipment.
Issues
The types of equipment whose purchase might be stimulated by this
provision would use various forms of combustible waste as a source
of heat and in electrical generating systems in: combination with oil or
other sources of fuel. In addition, equipment that can be used in re-
cycling discarded materials, or in preparing materials for recycling
also would be eligible for this special credit.






59

The issue is whether a special tax incentive is needed to stimujlate
tlhe use of these types of equipment instead of relying on price-co.t
relationships and the ordinary investment (credit to encoura 'e this
form of petroleum conservation.
Exypltltion of provision
The provision establishes a 12-percent investment for equipment ac-
quired after December 31, 1976, and placed in service before January 1,
19S2. This credit would revert to the statutory rate in effect in 1982.
Waste conversion equipment is defined to include equipment to lisse
waste as a fuel, process waste into a fuel, sort and prepare waste for
recycling, and recycling equipn ei it.
This provision (and most of the following provisions) were origi-
nially agreed to by the Finance Committee in its consideration of H.R.
6860. The provision at that time was suggested by the staff as a replace-
minent, for the House provision establishing five-year amortization for
this type of equipment.
Re renue effect
Budget receipts would be reduced by this provision by $2 million in
fiscal vear 1977 and $5 million in fiscal years 1978 and 1981.
d. Organic fuel conversion equipment
Present law
There are no tax provisions that relate specifically to organic fuel
conversion equiipment.
Issues
The proces-es for converting organic materials into enieriy or
methanol or other synthetic fuels are known and are technologically
feasible.
The issue is whether a temporary, special tax incentive is an ade-
quate and desirable stimulus to the commercial introduction anld utili-
zation of this equipment.
Explanation of pyoi';.?io/,
An, investment credit of 12 p(ereeit would be provided for equipment
acquired after December 31, 1976(i, and placed in service before Janu-
ary 1, 1982. After that date, the ordinary rules of the current invest-
ilnent credit would apply to this equipment. Organic fuel conversion
equipment is defined to mean any depreciable machinery or eillipment
used in converting organic materi.1 (other than waste material) into
energy or into methanol or any other synthetic fuel which can be sub-
stituted for, or blended with, any petroleum product for use as a fuel.
e. Railroad equipment
Present law
No special tax provision is applicable to expenditures for these kinds
of railroad equipment. Railroad rolling stock was eligible for five-year
amortization through December 31, 1975, when the provision expired;
the investment credit was not available to equipment for which an
election had been made for rapid amortization. Alternatively, thle rail-
road could take the investment credit and use ADR guideline lives
with accelerated depreciation. For communications systems, classifica-
tion yard equipment and freight handling equipment, the taxpayer
74-37 3-76---5






60

also may take the investment credit and use ADR guideline lives with
accelerated depreciation.
Issue
llaihroads for a number of years have been trying to increase invest-
ments in rolling stock, i.e., freight cars and locomotives, to keep pace
with the continuing growth in railroad traffic. In recent years, rail-
roads have found it necessary to rebuild or relocate classification yards
-s well as to install new equipment in those yards and elsewhere on
their systems, to modernize communications, signal and traffic control
systems and to install freight handling equipment for trailers and
containers.
The issue is whether a special tax incentive is desirable to assist the
railroads in carrying out these in vestment programs.
Explanation of provision
A 12-percent investment credit would be made available for rail-
road rolling stock, communications, signal or traffic control equipment,
classification yard equipment, and freight handling equipment for
loading or unloading trailers and containers on and from railroad cars
that have been placed in service after December 31, 1976, and before
January 1, 1982.
Revenue effect
Budget receipts would be reduced by this provision by $2 million ii:
fiscal year 1977 and $5 million in fiscal years 1978 and 1981.
f. Deep mining coal equipment
Pr,:..ent law
All coal mining equipment is eligible for the current investment tax
credit under the ordinary rules pertaining to all investment.
Issue
Current national policy seeks to increase reliance on domestic coal
resources as an alternative fuel for petroleum and natural gas. Coal
may be used directly as a fuel. or it may be converted into a liquid or
gaseous state which can be used directly as a substitute for certain kinds
of petroleum and natural gas. These objectives require substantial
increases in coal mining capacity which in turn demand substantial
investment in equipment to open and operate deep mines where the
major coal reserves are located.
The issue is whether an additional two percentage points on the in-
vestment tax credit, or an alternative tax incentive, for a temporary
period is needed to accelerate the process of opening new mines and
extending existing mines to new and deeper coal seams, thereby rapidly
incvre :lsijLr current coal mining production levels.
Explanation of pro rsion
The provision allows a 12-percent investment credit for deep mining
coal equipml)lent placed in service after December 31, 1976, and before
January 1, 1987. This provision covers depreciable equipment needed
to reach underground coal deposits in slope mines, shaft mines, or drift
mines and to extract the coal and bring it to the surface. It applies to
tlie machines and equipment used in the process of actual mining, in-
cluding colveyor belts, loading iiunchines. and cars used to bring coal







and miners out of the mine. The credit also applies to machinery and
equipment used in newly opened mines, in new shafts or tunnels in
existing mines and in reopened shafts or tunnels.
Revenue effect
Budget receipts would be reduced by this provision by $11 million
in fiscal year 1977, $27 million in 1978 and $42 million in 1981.
g. Coal liquefaction and processing equipment
Present law
Coal liquefaction and processing equipment are eligible for the cur-
rent investment tax credit under the ordinary rules pertaining to all
investment.
Issue
Current national policy seeks to increase reliance on domestic coal
resources as an alternative fuel for petroleum and natural gas. Coal
may be used directly as a fuel, or it may be converted into a liquid or
gaseous state which can be used directly as a substitute for certain kinds
of petroleum and natural gas. Converting coal into alternative forms
of fuel demands substantial investment in equipment to perform essen-
tially new production processes.
The issue is whether an additional two percentte 1)oints on the
investment tax credit, or an additional tax incentive, for a temporary
period is needed to accelerate the beginning of the industrial produc-
tion of liquefied or gasified coal products.
Explanation of provision
Thle provision permits a 12-percent investment credit for the capital
cost of depreciable machinery or equipment useod for 1)rocessin" coal
into a liquid or gans. This provision covers the range of liquids and(
gases which can be derived from coal (as well as usable byproducts),
including low-BTU gas. high-BTU gas, synthetic crude oils and chem-
ical feedstocks. In addition to gasifiers, reactors, and other equipment
directly involved in processilng the coal, eligible machinery and equip-
ment includes the facilities for coal preparation and crushing; for
upgrading coal oil to synthetic crude oil; for recovering solvent aind
sulfur; for preparing and disposing of water; and for product sto';ie.
Equipment used to drill wells, or to fracture coal in a mine "alnd to pipe
process gas to the surface, as part of underground gasification, is also
included. The credit is also to be available for equipment used in the
solvent refining process to remove sulfur, ash or other pollutants in
order to produce a clean solid fuel from coal. The provision also p)er-
mits machinery and equipment used in demonstration and pilot plants
:and in other testing activities (as well as machinery and equipment
.sed in commercial production) to receive the extra credit if the equip-
inent is the type that, if used in a trade or business, would be depreci-
able.
The credit would be available for eligible property that is placed in
service after December 31,1976. and before January 1,1987.
h. Coal slurry pipeline equipment
Pr,..lnt 7q,,,
Coal slurttry pipeline equipment is eligible for the current investment
tax cled(lit under the ordinary rules pertaining to all inve,-tment.





62


Issue
Current. national policy se,,eks to increase reliance on domestic coal
rtsources as an alternative fuel for petroleum and natural gas. Coal
may be i!-,d directly as a fuel, or it may be converted into a liquid or
g(afeous state and used directly as a substitute for certain kinds of petro-
leum and natural gas. These objectives require substantial expansion
in the resour:es available: to transport coal from where it is miied to
where it is to be consumed or converted into another form of fuel.
The issue is whether an additional two points for a temporary period
on the investment tax credit, or an alternative tax incentive, will accel-
erate thef rate of investment in coal slurry pipelines an see up the
availability of coal in areas distant from the n mines.
E.p)lancation of provisioi
The provision allows a 10-year, 12-percent investment credit for
costs incurred in installing pipeline equipment to carry coal ina slurry.
Under the amendment, te credit is confined to the central elements of
the slurry system : the nmaini pipeline itself, the high-pressure main
pipeline pumps (including spare pnlmps) necessary to move the coal
tlhroiiul' the line. and control and communications equipment for oper-
ltine thae pumping stations. The amendment defines an eligible pipe-
line as depreciable tangible property which constitutes a coal slurry
pipeline and related(l equipment for transporting coal from the mine or
other gathering point over relatively long distances from the mine (or
from a related preparation plant) to another geographical area where
the customer is located or where barges, rail lines, or other facilities for
further shipment of the coal are located.
This provision would apply to equipment placed in service after
December 31, 1976, and befoi e Jan ia rvy 1,1987.
Re'eneme effect
Budget receipts would be reduced by $7 million in fiscal year 1977,
$17 million in 1978 and $28 million in 1981.
i. Shale oil conservation equipment
Pw-sent b-111
Shale oil conversion equipment is eligible for tlie current investment
tax credit under the ordinary rules pertaining to all inv-estment.
Issue
Shale oil is a fuel that can be substituted for petroletun, and current
national policy is to encourage development of many viable alterna-
tives to petroleum and natural gas. Shale rock has been known for
decades to contain oil, and the basic method for extracting oil from the
rock is; known. What is not known. however, is whether any of the
processes would be a profitable industrial venture.
The issue raised by this provision is whether a temporary increase of
two percentage points in the investment tax credit, or another com-
parable tax incentive, can stimulate and accelerate financially viable
production of shale oil.
Explanation of pro;-ion?
The provision establislie, a 12-percent investment credit for capital
expenditures for machinery or equipment which is neces.-ary to reach.





63


extract and convert shale rock into raw shale oil. The provision does
not cover expenditures for refining crude shale oil after it has been
extracted from the rock. It is intended to cover machinery and equip-
ment used to obtain water needed for the extraction process, to dispose
of spent shale after the oil has been extracted, to dispose of run-off
waters fro;n wastes produced in the extraction, and to remove impuri-
ties from oil and gas produced from the shale. This provision also
permits depreciable machinery and equipment used in demonstration
and pilot plants for shale oil extraction to receive the 12-percent credit.
This provision would apply to equipment placed in service after
December 31, 1976, and before January 1, 1987.
RevEnue effect
Budget receipts would be reduced under this provision by $4 million
in fiscal year 1977, $13 million in 1978 and $20 million in 1981.
j. TVA Conpcn.:satory adjustments
Present law
TVA is a wholly owned government corporation that is not taxable.
It is required to make annual payments to the Federal Government as a
return on the appropriated Federal funds invested in power facilities.
Issue
TVA uses coal as a fuel, instead of oil, for its electric power
generating facilities, and as many electric utility companies do,
TVA owns its own coal mines, is extending them and is opening new
mines. It needs transportation facilities, and it also must seek and
develop alternative sources of fuel. In this nvpect, it is behaving in the
.-ame way that its competitor private elect vic utilities are acting.
The issues raised are whether TVA's annual return to the Federal
Government of the investment of appropriated funds is to be treated
as though it were a payment of corporation income taxes and whether
that payment should be reduced by an investieniit credit for purchase
of certain types of facilities.
Expl, i' This provision was suggested by Senator Brock. The provision
would allow TVA to reduce its annual payment to the Federal Gov-
ernment by an amount equal to a 12-percent investment credit earned
on investments in equipment for organic fuel conversion, coal proc-
essing, coal slurry pipelines and shale oil conversion. Unused credits
would be carried forward to the next fiscal year.
The provision would apply to payments made on or after October
1, 1976.
49. Deductions for Production and Intangible Drilling Costs of
Geothermal Resources (sec. 2004 of the bill)
the bill)
Pre.wlw't law
Preseiit law is uwiifctled as to whether a depletion deductionii or the
intangible drilling cost deduction is allowable for the production of
geothermali steam and associated geothermial resources. These questions





64


were answered affirmatively for the taxpayers in the case of Reich v.
Commissioner, 454 F.2d 1157, 29 A.F.T.R. 2d 72-512 (C.A. 9, 1972).1
However, the Internal Revenue Service is apparently not following
thlat decision in cases arising outside of the Ninth Circuit.
The Tax Reduction Act of 1975 (94th Congress), generally elimi-
nated the depletion allowance for oil and gas, except for a continued
allowance for small producers. However, the depletion allowance for
geothermal resources was not to be affected by that Act. According
to the Conference Report (H.R. Rep. No. 94-120, p. 67):
For geothermal steam, present law is unaffected, so that if
steam is ultimately held by the courts to be a gas entitled to a
22-percent rate of depletion, this treatment will be continued.
As a result, the 22-percent depletion deduction allowable to gas
wells immediately prior to the 1975 Tax Reduction Act is still avail-
able for geothermal energy if courts should decide, as did the Reich
court, that a geothermal well is a gas well, and that the other require-
ments for depletion are met.
Under current law it is also possible that to the extent the costs of
geothermal energy development (including intangible drilling and
development costs) result in new processes or technology, they would
be considered as research and experimental expenditures subject to
the election to be currently deductible or to be amortized over a 60-
month period commencing when the taxpayer begins to receive bene-
fits from the expenditure. The Internal Revenue Service has ruled
in Revenue Ruling 74-67, 1974-1 C.B. 63, that certain costs of develop-
ing a method for hydraulic mining of hard minerals, including a por-
tion of the costs of drilling wells, are deductible as research and experi-
mental expenditures. However, under present law the costs of ascer-
taining the existence, location, extent, or quality of any deposit of
oil, gas, or other mineral are not deductible as research and experi-
mental expenditures.
Issue
The issue is whether the right to expense intangible drilling costs
currently and the depletion deduction allowance (or, as in the com-
mittee bill, something very similar to it) should be extended to the
production of geothermal steam and associated resources.
Explanation of provision
This provision was sponsored by Senator Fannin. The provision ex-
tends current expensing of intangible drilling costs and an additional
deduction for 22 percent of the gross income from the property 2
to the production of geothermal stem and associated geothermal re-
sources. This deduction is not to exceed 50 percent of the taxpayer's
taxable income from the geothermal steam and associated geothermal
1 In the Reich case, the Tax Court had held that the prodiiucrt of the taxi;iyers' geother-
mnial steam wells was a ian. and that the taxpayers as a result were entitled to expense
<.,rrentl y their intanvilIe drilliiin. costs (sec. 26.C",(c) of the code). The court held further
tina I the plaintiffs were entitled to the then 271 nerient depletion deduction allowance
for their product because (1) tlicir product was s(,ani. not in ilhaustible earth heaot. (2)
lthe particular -cotliermwa wells in question were exhauistible, (3) steam is a gas, and (4)
the exclusion from the ri'lit to depletion of "'water" in section 613(b)(7) of the code
,ins not exclude steam from the depletion allowance.
2 "'Pri,,'rty" is to have the ti.ain,.e -.ivci n it in section (14 of the code. which is to say
Ihat it i-Liis,.. in .'*niral. each sojoarate interest owned by the taxpayer in each mineral
%it I,, it in each sulpi rate tract or parcel of land.








resources property for the taxable year, computed without reod-rzd to
this 22 percent deduction. The normal depletion d, duction (section
611), however, is not allowed if a deduction under this, provision is al-
lowable. Thus, there cannot be any double d(edud ion in the nature of
depletion allowances regardless of whether the Internal Revenue Serv-
ice or the necessary courts should determine ultimately that geothermal
production is entitled to the depletion allowance.
It is intended that the term "22 percent of the gross income" is
intended to mean the fair market value of the geotheritial ste:ni and
associated geotheriiial resources at the wellihead. Thus, the g loss in-
come for which the percentage deduction is granted is not to include
expenses of selling the steam or other geothermni resource such as costs
of bringing the steam to the consuliner.
The committee decided to provide a new deduction for this fledgling
industry, rattler than to clarify the existing sections of the code per-
taining to depletion. This is done to avoid some of the technical ques-
tions wlhicl traditionally surround the depletion allowance. For
example, this approach permits the steam or other geothermal re-
source to be entitled to the new deduction whether or not the steam or
other geothermal resource from the property in question is e-haustible
in nature.
The term "geothermal steamy or associated geothermal resource" is
the term used in the Geothermal Steam Act of 1970. In accordance
with a number of the definitional provisions of that Act, the commit-
tee intends the term "associated geothermal resource" to include ]lot
brine, dry heat (that may be produced with thlie use of such a substance
as freon) and hot water (such as that \which may be (sed directly to
heat a building equipped with a heating unit employing hot water
heating) and the other resources included in that Act. However, the
tax benefits conferred by this amendment are not to extend to such
minerals as are sometimes produced in the course of geothermal pro-
duction, such as sodium, calcium, and trona. Furthermore, the term
"geothermal steam and geothermal rcsurces property" is to mean
property from which the taxpayer exLtracts any product included in
geothermal steain and associated geothermal resources, as defined by
the Geothermal Steam Act of 1970.
The provision specifically requires that in order to be eli 'ible for
this deduction, the taxpayer must be the holder of an "economic
interest" in the geothermal energy property. This is necessary to
insure that the party who is taking the deduction did not acquire a
mere economic advantage in the property in order to qualify for the
deduction. The term "economic interest" as used in this amendment
should be given the same meaning as the term has for purposes of
computing depletion in the case of oil or gas wells.
Although the deduction provided for in this amiiedment is termed
a "business deduction", it is to be allowable to the holders of passiv,
interests in a geothermall eneirg'y property, such as holders of a land-
owner's retained royalty, an overriding royalty, or a net profits inter-
est. It is not to be limited to holders of iiin operating interest, such as
a working interest in the property.
The deductions of section 617 of the code for expenses paid or in-
cirred for mining exploration before the beginning of the develop-
iiieiit stage of the mine are not to be allowed to geotlierm ial production






66


which enjoys the benefits of the current expensing of intangible drill-
ing costs and the 22-percent deduction provided by this provision.
The 22-percent deduction provided in the committee amendment is
to constitute an itemn of tax preference (under section 57(a) (8) of the
Code) for purposes of the minimum tax on tax preferences. Thus, the
excess of the deduction over the adjusted basis of the property at the
end of the taxable year (determined without regard to this deduction)
is an item of tax preference.
In the case of leases, the new 22-percent deduction is to be appor-
tioned between the lessor and the lessee. In the case of property owned
for life by one person, with the remainder owned by another, the en-
tire deduction is to be allowed to the life tenant. In the case of property
held in trust, the deduction is to be apportioned between the income
beneficiaries and the trustee in accordance with the trust provisions,
or, if there are none, on the basis of the trust income. allocations. In the
case of an estate, the deduction is to be apportioned between the estate
and the heirs, legatees, and devisees on the basis of the income of the
estate allocable to each.
The provision generally benefit? purchasers and manufacturers of
solar and geothermal equipment. Among those expressing an interest
in this provision are Union Oil Company, San Diego Gas and Electric.
Geothermal Resources Intern-,ational, Earth Power Corporation, Geo-
tlienmnal Kinetics, Inc., Geosystems, Inc., and Thermal Resources, Inc.
Revenue effect
It is estimated that current expensing of intangible drilling costs of
geothermal properties and the deduction for 22 percent of gross income
from geothermal properties will reduce receipts by $7 million for fiscal
1977, $15 million for fiscal 1978, and $21 million for fiscal 1981.
50. Recycling Tax Credit (sec. 2006 of the bill)
Present law
There is no provision in present law for a recycling tax credit or any
other tax incentive to encourage salvage and reclaiming of materials
as a means to conserve natural resources, reduce energy consump-
tion, and reduce environmental litter. In section 611 and 613 of
the Code, a schedule of percentage depletion rates is provided for
various metals and minerals to encourage their discovery, development
and mining so that the metals and minerals may be made available for
industrial use. Percentage depletion also is provided to the owners of
these materials because they are irreplaceable assets. Capital gains
treatment is available on timber income and on royalties from coal and
iron ore.
Issues
The issues are whether recyclers should be allowed a tax credit in
order to give them tax incentives comparable to the treatment of virgin
materials and, if so, whether the tax credit should be based on the
increase in recycling over a base period.
Explanation of provision.
Tlhis provisiolln w\s sponsored 1)v Senator Gravel. The provision
establishes a tax credit to a recycler for pulrchlases of recyclable solid
waste materials that exceed 75 percent of the base period amount. A.
qualified recycling purchase is the amount paid by a recycler for re-
(cyclable solid waste material to li1 recycled in thle United States for
use in the United States.







The credit for ferrous and nonferrous metals could be one-half
of the percentage depletion allowance provided for them, 10 percent
for textile and paper waste, and 5 percent for glass and plastics.
No credit is allowed by recycling gold, silver, platinum or other
precious metals. The credit allowed for paper waste would be limited
to a range of $5.50 and $8.00 per ton.
For recyclers in operation before 1973, the base period amount
would be 75 percent of the average annual purchases for the calendar
years 1973, 1974 and 1975 through December 31, 1980. After that
date, the base period would be the 3 taxable years preceding each
taxable year, and the base period amount then would become 75 per-
cent of the average annual purchases during the 3-year periods.
For a new recycler after 1975, the base period amount in his first
year'of recycling prodLiction would be zero. For his second year of
production, the base period amount would be 75 percent of the first
year's purchas-s divided by 3. For the third year, the base period
1i\nount would be the purchases in the first 2 years divided by 3, and
for his fourth year of production, he would have 3 years of prior ac-
tivity to establish a base period.
The recycling credit is phased in during its first 3 years. The
phasein provision limits the recycling credit in thle first year to 25
percent and to 50 percent in the second ye;tr. The full amount of the
credit earned by qualified purchases would be available for the third
and subl)sequent years.
Recvlable solid waste materials are defined as materials which
must ha ve been used bv an ultimate consumer and have no si2nificaInt
value or utility except as waste. Discarded containers from industrial
plants are wastes that have been used by an ultimate consumer.
"Wastes that result from a fabrication process may be classified as
n)ostconsumer solid wastes, if they are not reusable by the fabricator
-n his process, and neither the fabricator nor a related person may
be engaged in the manufacture that discards such wastes or in proc-
ess ing th be waste material.
Recycling means a treatment which alters the composition or physi-
cal properties of a material and which transforms the material into
a product or material which does not constitute recyclable solid waste.
Recycling does not include a process consisting merely of sorting,
shredding, stripping, compressing, and packing for storage and
shipment.
A purchase is not a qualifying purchase if the waste material is
acquired from a relative, a corporate affiliate or subsidiary or in a
tax-free ex.chanie as under section 179(d) (2) of the Code.
Interest-in this provision has been expressed by National Associates
of Recycling Industries and the American Paper Institute.
Revenue effect
This provision will reduce budget receipts by $9 million in fiscal
1977, $39 million in fiscal 1978. and $345 million in fiscal 1981.
51. Repeal of Manufacturers Excise Tax on Buses and Bus Parts
(see. 2007 of the bill)
Present law
UTnder present law, a 10-percent manufacturers excise tax is imposed
on the sale of buses having a gross vehicle weight of more than 10,000
74-375-76---6






68


pounds (sec. 4061(a)).1 However, present law provides for an exemp-
tion from this tax for "local transit buses"; that is, those buses "which
are to be used predominantly by the purchaser in mass transportation
service in urban areas" (sec. 4063 (a) (6) ).2 The tax also does not ap-
ply to school buses for "exclusive" use in transporting students and
employees of schools operated by State or local governments or by
nonprofit educational organizations (sec. 4221 (e) (5)).3
In addition, there is an 8-percent manufacturers excise tax on parts
and accessories (other than tires and inner tubes, which are taxed
separately under sec. 4071) of the type used on buses (sec. 4061
(b)).4
8Issues
Bus transportation is a more energy-efficient mode of transportation
than is automobile transportation, and there is no excise tax on the
purchase of automobiles (since the repeal by the Revenue Act of 1971).
One way to encourage the purchase of new private buses is to re-
move the 10-percent excise tax. In addition, there is the present tax
distinction between exempt urban transit buses and taxable intercity
buses. If the tax on buses is repealed, it is argued that the tax on bus
parts should also be removed as there is no tax on automobile parts.
Explanation of provision
The provision repeals the 10-percent excise tax on all buses as well
as the related 8-percent tax on bus parts and accessories. The House
energy tax bill (H.R. 6860) provided for a repeal of the 10-percent
excise tax on intercity-type buses only; that is, buses which would be
used "predominantly by the purchaser in public passenger transpor-
tation service."
The repeal of the tax on buses and bus parts is effective for sales by
the manufacturer, producer, or importer on or after the date of en-
actment. (The Committee Report incorrectly states that the provision
is effective on or after July 1, 1976.) An article is not to be considered
as sold before the date of enactment unless possession or right to
possession passes to the purchaser before that time.
Revenue effect
It is estimated that this provision will reduce receipts by $19 mil-
lion for fiscal year 1977, $20 million for fiscal year 1978, and $12 mil-
lion for fiscal year 1981. (The fiscal 1981 figure is based upon the
scheduled reduction in the 10-percent and 8-percent excise taxes de-
scribed above to 5 percent as of October 1, 1979, the scheduled expira-
tion date of the Highway Trust Fund under present law.) These rev-
enues would otherwise go into the Highway Trust Fund (through
September 30, 1979).
1 This tax is scheduled to drop to 5 percent on and after October 1. 1979.
2 This exemption applies to privately-owned local transit buses, since "public" transit
buseps are exempted under the State-local government exemption provision (sec. 4221
(a) 4) ).
T This npplils to persons purchasing school buses for contract operation to transport
sc.iol students or employes,. as school buses sold directly to State-local governments or
to nonprofit w nationalal or-,iizatiori., for their exclusive use are exempted already
1r,. 4221 (a)(4) and (5)).
This tax is also scheduled to be reduced to 5 percent on October 1, 1979.






69


52. Exemption From the Retailers Excise Tax on Special Motor
Fuels for Certain Nonhighway Use (sec. 2009 of the bill)
Present law
Present law imposes a retailers excise tax of 4 cents a gallon upon
diesel fuel and certain other special motor fuels where the fuel is
sold or used for highway-related vehicle use. In the case of die-el
fuel, no tax is imposed upon the use of diesel in a nonhighway motor
vehicle nor in a motorboat, as the tax is imposed only if sold for
or used by a "diesel-powered highway vehicle" (sec. 40.41 (a)). How-
ever, for the other special motor fuels, there is a tax of 2 cents a
gallon for use by a nonhighway motor vehicle or motorboat (sec,
4041(b)).2
Issue
The issue is whether nondiesel special motor fuel should be treated
the same as is diesel motor fuel when used for nonhighway purposes.
Explanation of provision
This provision was first considered by Finance Committee (and then
adopted) during its consideration of H.R. 6860, the energy bill. The
House energy bill repealed the tax only on buses operating within
metropolitan areas.
The provision establishes an exemption from the 2 cents-a-gallon
retailers excise tax on special motor fuels sold or used for a nonhigh-
way motor vehicle (other than for motorboat or noncommercial avi-
ation use). This will remove the tax distinction between, for example,
liquefied petroleum gas (propane) used in an industrial lift truck
(which is subject to a tax of 2 cents a gallon) and diesel fuel used in
a diesel-powered lift truck (which is not subject to any fuel tax).
The exemption is accomplished by providing for the refund or credit
(under sec. 6427) for tax paid for such nonhighway use of special
motor fuels.
This provision will benefit major bus lines, including Greyhound
and Trailwvays.
This provision is effective for the use of certain special fuels for
nonhighway motor vehicles as described above on or after July 1,
1976. Eaton Corporation and the National Liquified Petroleum Gas
Association have expressed an interest in this provision. The provision
will also benefit other companies.
Revenue effect
It is estimated that this amendment will involve a small revenue loss.
53. Oil Swaps (see. 2010 of the bill)
Present law
Under present law, all petroleum and petroleum products imported
into the United States are subject to import duties, which vary accord-
ing to grade of petroleum or type of product.
The special motor fuels are benzol, benzene, naphtha, liquefied petroleum gas, sing
head and natural gasoline or any other liquid (other than kerosene, gas oil, fuel oil. or
any product taxable as gasoline under section 4081 or as diesel fuel under section
4041 (a)). This tax is scheduled to be reduced to 11/2 cents a gallon on October 1, 1979.
2'This 2 cents-a-gallon reduction in the retailers excise tax on special motor fuel does
not apply to such fuel for noncommercial aviation use, as there is a separate retailers tax
of 7 cents a gallon through June 30, 1980 (sec. 4041 (c)).





70


Canada has announced a policy of gradually reducing its crude oil
exports to the United States to zero by the early 1980's. subject to
annual reevaluation. United States refiners in several Northern Tier
States including Michigan, Mimesota, Montana, North Dakota and
Wisconsini, currently rely heavily on crude oil imported from the
Northwestern Canadian Provinces.
Issue
The issue is whether it is necessary or appropriate to remove U.S.
import duties from oil imported from Canada pursuant to swap
arrangements in order to promote a joint U.S.-Canadian energy
policy.
Explanation of provision i
This provision was sponsored by Senator Mondale. The provision
allows the duty-free treatment of oil imported from Canada under
company-to-company oil swap arrangements made pursuant to agree-
ment between the governments of the United States and Canada. The
House bill contains no similar provision.
Under the provision, the United States tariff schedules are modified
to exempt oil imported from Canada into the United States from the
import duties set forth in Schedule 4, part 10 of tliese schedules, if
the oil is imported as part of an oil swap arrangement. The types of
petroleum eligible for such swaps are crude petroleum, including
reconstituted crude petroleum, and crude shale oil. The quantity of
imported Canadian oil exempted from U.S. duties must be equivalent
in amount, kind, and quantity to the oil which is imported by Canada
from United States refiners during the 30-day period preceding the
date of entry of the Canadian oil into the United States.
The amount of Canadian oil entering the United States duty-free
cannot be offset against any merchandise except the.oil exported by
United States refiners to Canada. In order for the Canadian oil to
qualify for duty-free entry, the oil exported by United States refiners
under the swaps must be either domestic United States oil or oil from
foreign sources on which United States refiners have already paid the
United States import duties.
The amendment provided by this provision has been requested by
the Koch Refining Company, Wichita, Kansas, which operates rer
finery in Pine Bend. 1Minnesota. However, the provision has general
application to any U.S. refiner participating in U.S.-Canadian oil
swaps.
The provision applies to taxable years beginning after December 31,
1976.
This provision will benefit U.S. consumers who under the provision
will be able to obtain Canadian oil at prices cheaper than the cost of
transporting American oil to that part of the country.
Revenue effect
This provision is not expected to have any effect on tax receipts.
54. Modification of Transitional Rule for Sales of Leased Prop-
erty by Private Foundations (sec. 2101 of the bill)
Present law
The Tax Reform Act of 1969 imposed taxes upon certain transac-
tions between a private foundation and its "disqualified persons"






71


(generally, persons with an economic or managerial interest in the
operation of that foundation). Among the transactions to which these
taxes on "self-dealing" apply are the sale, exchange, or leasing of
property (sec. 4941). In order to avoid unnecessary disruption of exist-
ing arrangements, however, the Act provided transitional rules per-
mitting the continuation, without violation of the self-dealiiing rules,
of any existing lease (in effect on October 9, 1969) between a founda-
tion and a disqualified person until 1979, so long as the lease remains
at least as favorable to the private foundation as it would have been
under an arm's-length transaction between unrelated parties. How-
ever, for taxable years beginning after the end of 1979, the leasing
arrangements must be terminated (sec. 101 (1) (2) (C) of the 1969
Act).
Another transitional rule provided in the 1969 Act permits a private
foundation to ,ell excess business holdings to a disqualified person, if
the sales price equals or exceeds the fair market value of the property
being sold. However, this rule applies only to business holdings, and
not to passive investments, including passive leases (sec. 101 (1) (2) (B)
of the Act).
In some instances a priv-ate foundation is leasing to a disqualified
person property of a nature which is peculiarly suited to the use of that
person. In these cases, it is argued that the value of the property to the
disqualified person is greater than that to any other person. It is fur-
ther argued that, since under present law such a leasing arrangement
must be terminated not later than the end of the last taxable year
beginning in 1979, and the property cannot be sold to the disqualified
person by the private foundation, the foundation probably would be
put in the position of being forced to dispose of its property to unre-
lated persons for less than the value of that property to disqualified
persons.
This particular combination of circumstances rewarding the sale of
leased property was not brought to the attention of Congress when it
was considering the Tax Reform Act of 1969. In effect, the sale-of-
leased-property situation happens to fall between the above-noted
existing transitional rules. Some feel that if this particular point had
been presented in 1969, the Act would have been modified to deal with
the situation.
I.9S f/
The issue is whether an additional transitional rule should be pro-
vided under which a private foundation could sell, exchange, or other-
wise dispose of (for fair market value) leased property to a disquali-
fied person who is leasing such property, without the imposition of a
self-dealing tax.
Explanation of provision
This provision was sponsored by Senator Mondale. The provision
revises the transitional rules applicable to the private foundation pro-
visions of the Tax Reform Act of 1969 by adding a new transitional
rule to deal with the sale of property by a private foundation to a dis-
qualified person. Under this rule, a private foundation could sell,
exchange, or otherwise dispose of property (other than by lease) to a
disqualified person if, at the time of the disposition, the foundation is
leasing substantially all of that property under a lease siuliect to the





.72

1979 lease, transitional rule described above, and the foundation
receives in return an amount which equals or exceeds the fair market
value of the property. In computing the fair market value of the
property, no diminution of that value is to result from the fact that
the property is subject to any lease to disqualified personS.
The fair market value of the property is to be determined either at
the time of its disposition, or at the time (after June 30, 1976) that a
contract is executed for disposition of the property. The contractual
valuation date permits the foundation and the purchaser to have a
fixed price in their agreement even though some time may elapse and
the value of the property changes between the contract and the actual
settlement date.
This provision applies to dispositions occurring before January 1,
1978, and after the date of the bill's enactment, in taxable years ending
after the date of the bill's enactment.
The Lund Charitable Foundation expressed an interest in this
provision.
This provision originally was requested by the Charles W. Wright
Foundation and Badger Meter, Inc. The provision is expected to have
application to a number of other foundations and disqualified persons;
however, its limitation to property subject to the 1969 Act transitional
rule as to leases necessarily limits the number of cases that can arise
under the provision.
55. Extension of Time To Conform Charitable Remainder Trusts
for Estate Tax Purposes (sec. 2104 of the bill)
Present law
The Tax Reform Act of 1969 imposed new requirements which
must be satisfied by a charitable remainder trust in order for an estate
tax deduction to be allowed for the transfer of a remainder interest
to charity. Under these new requirements, no estate tax deduction is
allowable for a remainder interest in property (other than a remainder
interest in a farm or personal residence) passing at the time of a
decedent's death in trust unless the trust is in the form of a charitable
remainder annuity trust or unitrust or pooled income fund. These
rules generally apply in the case of decedents dying after December 31,
1969. However, certain exceptions were provided in the case of wills ex-
ecuted or property irrevocably transferred in trust on or before Octo-
ber 9,1969. In general, these exceptions did not apply the new rules to
these wills and trusts until October 9, 1972 (unless the will was modi-
fied in the meantime) to allow a reasonable period of time to take the
new rules into account.
In 1970, the Internal Revenue Service issued proposed regulations
with respect to the new requirements for a charitable remainder
annuity trust or unitrust (under sec. 664 of the code). These regula-
tions provided additional transitional rules allowing trusts created
after July 31, 1969, (which did not come within the statutory excep-
tions) to qualify for an income, estate or gift tax deduction if the
governing instrument was amended prior to January 1, 1971. Subse-
quently, the date by which the government instrument had to be
amended was further extended by the Internal Revenue Service.' On
1 T.I.R. 1060 (December 13, 1970) extended the date to June 30, 1971; T.I.R. 1085
(June 11, 1971), extended the date to December 31, 1971; T.I.R. 1120 (December 17. 1971) ;
extended the date to June 30, 1972; and T.I.R. 11S2 (June 29, 1972), extended the date
to the 90th day after final regulations were Issued.





73


August 22, 1972, the Internal Revenue Service issued final regulations
which further extended the date to December 31, 1972. On September 5,
1972, the Internal Revenue Service published Rev. Rul. 72-395 which
provided sample provisions for inclusion in the governing instrument
of a charitable remainder trust that could be used to satisfy the
requirements under section 664.
In 1974, Congress extended the date by which the governing instru-
ment of a trust created after July 31, 1969, and before September 21,
1974, or pursuant to a will executed before September 21, 1974, could
be amended (P.L. 93-483). Under this Act, if the governing instru-
ment is amended to conform by December 31, 1975, to meet the re-
quirements of a charitable remainder annuity trust or unitrust or
pooled income fund, an estate tax deduction will be allowed for the
charitable interest which passed in trust from the decedent even though
the interest failed to qualify at the time of the decedent's death.
Where a judicial proceeding is required to amend the governing
instrument, the judicial proceeding must begin before December 31,
1975, and the governing instrument must be amended to conform to
these requirements by the 30th day after the judgment becomes final.
In any case, where the governing instrument is amended after the
due date for filing the estate tax return, the deduction will be allowed
upon the filing of a timely claim for credit or refund (sec. 6511) of an
overpayment. However, no interest will be allowed for the period prior
to the end of 180 days after the claim for credit or refund is filed.
Issue
The issue is whether to permit executors and trustees an additional
period of time during which they can amend charitable remainder
trusts to conform to the 1969 Act rules.
Explanation of provision
This provision was presented by Senator Curtis. The provision
extends to December 31, 1977, the date by which the governing
instrument of a charitable remainder trust created after July 31,
1969, must be amended in order to qualify as a charitable re-
mainder annuity or unitrust or pooled income fund for purposes of
the estate tax deduction. The provision also extends the date in the case
of a trust created after July 31, 1969, pursuant to a will executed
before December 31, 1977. Under the provision, if the governing in-
strument is amended by December 31, 1977, to conform to the re-
quirements of a charitable remainder annuity or unitrust of pooled
income fund, an estate tax deduction will be allowed for the charit-
able interest which passed in trust from the decedent even though
a deduction originally was not allowed for this interest because the
trust failed to qualify as a charitable remainder trust at the time of the
decedent's death. This applies to trusts created after July 31, 1969,
and before January 1, 1978. For these purposes, a trust which first
became irrevocable, in whole or in part, after that date is treated as
having been created after that date.
This amendment applies with respect to decedents dying after
December 31,1969.
This provision is generally applicable to trusts created after July 31,
1969 which aire. charitable remainder trusts.






74


Revenue effect
It is estimated that this provision will decrease budget receipts by
$5 million during fiscal year 1977 and 1978.
56. Income From Fairs, Expositions, and Trade Shows (sec. 2106
of the bill)
Present lai1
Under present law, the unrelated business income tax applies to
income from the conduct by an exempt organization of an unrelated
trade or business. The term "unrelated trade or business" means any
trade or business the conduct of which is not substantially related
(aside from the need of such organization for income derived from
such trade or business) to the exercise of its exempt purpose. The term
"trade or business" includes any activity which is carried on for the
production of income from the sale. of goods or services. The law fur-
ther provides that, for the purpose of defining the trade or business
activity, the activity is not to lose its identity as a trade or business
merely because it is carried on within a larger aggregate or similar
activities or within a large complex of other endeavors which may
(or may not) be related to the exempt purposes of the organization.
One major purpose of this provision is to make certain that an
exempt organization does not commercially exploit its exempt status
for the purpose of unfairly competing with taxpaying organizations.
An example of such activity specifically cited in the law is the carry-
ing of advertising in a journal published by an exempt organization.
In one case (Rev. Rul. 68-505, 1968-2 C.B. 248), the Internal Reve-
nue Service ruled that an exempt county fair association which con-
ducts a horse racing meet with parimutuel betting is carrying on an un-
related trade or business subject to the unrelated business income tax.
In another case, the Service has held. in a series of revenue rulings
(TIR-1409, 1975-2 C B. 220-226), that income that an exempt business
league receives at its convention trade show from renting display space
may constitute unrelated business taxable income if selling by the
exhibitor is permitted or tolerated at the show.
Issue
The issue is whether these types of activities compete unfairly with
taxpaying organizations such that the income from these activities
should be subject to tax as unrelated business taxable income.
Explanation of pror;ion^.
This provision was sponsored by Senator Pac-kwood (in the case of
fairs and expositions) and by Senator Dole (for trade shows).
In the case of fairs and expositions, the provision applies to an
organization which is exempt under section .501 (c) (3), (4) or (5) of
the Code (charitable, social welfare, or agricultural) and which oper-
ateo a qiJlified public entertainment activity that meets one of the
following conditions:
(1) the public entertainment activity is conducted in conjunction
with a pmblic international, national, State, regional, or local fair or
exposition;:
(2) the nf-vitv is enndivcte, in ,Ier',ln-len, vwifth Sfqte law which
prmits thaf activity to be ,oiwnlu.ot, only by that type of exempt orga-
nization orby a governmental entity; or





75


(3) the activity is conducted in accordance with State law which
allows that activity to be conducted for not more than 20 days in any
year and which permits the organization to pay a lower percentage of
the revenue from this activity than the State requires from other
organizations.
In order to qualify for this treatment, the organization must regu-
larly conduct, as one of its substantial exempt purposes, a fair or expo-
sition which is both agricultural and educational. Thus, a book fair
held by a university does not come within this provision since such a
fair is not an agricultural fair or exposition.
In the case of conventions and trade shows, the provision applies to
an organization which is exempt under section 501(c) (5) or (6) of
the Code (generally, unions or trade associations) and which regularly
conducts as one of its exempt purposes a convention or trade show
activity which stimulates interest in, and demand for, an industry's
products in general. In order to constitute a qualifying convention and
trade show activity all the following conditions must be met:
First, it must be conducted in conjunction with an international,
national, State, regional, or local convention or show;
Second, one of the purposes of the organization in sponsoring that
activity must be the promotion and stimulation of interest in, and
demand for, the industry's products and services in general; and,
Third, the show must promote that purpose through the character
of the exhibits and the extent of the industry products displayed.
The conducting of qualified public entertainment activities and
qualified convention and trade show activities is not to subject the
organization to the unrelated business income tax and the conducting
of such activities is not to affect the tax-exempt status of the
organization.
This provision applies to taxable years beginning after Decem-
ber 31, 1962, with respect to qualified public entertainment activities
and to taxable years beginning after December 31, 1969, with respect
to qualified convention and trade show activities.
The provision with respect to fairs has general applicability to a
number of States. In addition the provision includes special rules to
cover problems with respect to the laws in two States-Oregon and
Nebraska. In the case of Oregon, since the State law only allows an
exempt organization to have five days of racing a year. it is not
profitable for them to build a separate race track. As a result, a com-
mercial track is rented but in order not to compete with the fair
itself, the period of time for racing is not conducted during the period
the fair is being held. In the case of Nebraska, the State law does not
permit horse racing by other than exempt organizations. Thus, there
is no competition with any commercial activity and the amendment
covers the exempt organizations in this case. The organizations ex-
pressing an interest in this provision are as follows: Pacific Inter-
national Livestock Exposition in Oregon. AKSARBEN in Nebraska,
the Maryland State Fair, and the Los Angeles County Fair.
The National Society of Association Executives expressed interest
in the provision as it applies to trade shows.
57. Generation-Skipping Transfers (sec. 2202 of the bill)
Present law
Under present law, a Federal gift or estate tax is generally imposed
upon the transfer of property by gift or by reason of death. However,





76


the termination of an interest of a beneficiary (who is not the grantor)
in a trust, life estate, or similar arrangement is not a taxable event
unless the beneficiary under the trust has a general power of appoint-
ment with respect to the trust property.
This result (nontaxability) occurs even when the beneficiary under
the trust has: (1) the right to receive the income from the trust; (2)
the power to invade the principal of the trust, if this power is subject
to an ascertainable standard relating to health, education, support,
or maintenance; (3) a power (in each beneficiary) to draw down an-
nually from his share of the principal the greater of 5 percent of
its value or $5,000; (4) a power, exercisable during life or by will, to
appoint any or all of his share of the principal to anyone other than
himself, his creditors, his estate or the creditors of his estate; or (5)
the right to manage the trust property by serving as trustee.
Currently, all States (except Wisconsin and Idaho) have a rule
against perpetuities which limits the duration of a trust. While the
rules of the different States are not completely uniform, in general,
such laws require that the ownership of property held in trust must
vest in the beneficiaries not later than the period of the lifetime of any
"life in being" on the date of the transfer, plus 21 years (and 9
months) thereafter.
Issue
The purpose of the Federal estate and gift taxes is not only to
raise revenue, but also to do so in a manner which has as nearly as pos-
sible a uniform effect, generation by generation. These policies of
revenue raising and equal treatment are best served where the transfer
taxes (estate and gift) are imposed, on the average, at reasonably
uniform intervals. Likewise, such policies are frustrated where the
imposition of such taxes is deferred for very long intervals, as is possi-
ble, under present law, through the use of generation-skipping trusts.
Present law imposes transfer taxes every generation in the case of
families where property passes directly from parent to child, and then
from child to grandchild. However, where a generation-skipping trust
is used, no tax is imposed upon the death of the child, even where the
child has an income interest in the trust, and substantial powers with
respect to the use, management, and disposition of the trust assets.
While the tax advantages of generation-skipping trusts are theoreti-
cally available to all, in actual practice these devices are more valuable
(in terms of tax savings) to wealthier families. Thus, generation-
skipping trusts are used more often by the wealthy.
Generation skipping results in inequities in the case of transfer
taxes by enabling some families to pay these taxes only once every
several generations, whereas most families must pay these taxes every
generation. Generation skipping also reduces the progressive effect
of the transfer taxes, since families with moderate levels of accumu-
lated wealth may pay as much or more in cumulative transfer taxes
as wealthier families who utilize generation-skipping devices.
There are many legitimate nontax purposes for establishing trusts.
However, many believe that the tax laws should be neutral and that
there should be no tax advantage available in setting up trusts. Thus,
the issue is whether property passing from one generation to successive
generations in trust form should, for estate tax purposes, be treated
substantially the same as property which is transferred outright from
one generation to a successive generation.






77


Explanation of provision
This provision was sponsored by Senator Haskell. The provision
imposes a tax in the case of generation-skipping transfers under a
trust or similar arrangement (such as a life estate) upon the dis-
tribution of the trust assets to a generation-skipping heir (for
example, a grandchild or the transferor) or upon the termination of
an intervening interest in the trust (for example, the termination of
an interest held by the transferor's child).
The tax would be substantially equivalent to the estate or gift tax
which would have been imposed if the property had actually been
transferred outright to each successive generation. For example, where
a trust is created for the benefit of the grantor's child, with remainder
to the grandchild, then, upon the death of the child, the tax would be
computed by adding the child's portion of the trust assets to the child's
estate, and computing the tax at the child's marginal estate tax rate.
Thus the child would be treated as a "deemed transferor" of the
trust property. The child's estate tax brackets are used as a measuring
rod for purposes of determining the tax imposed on the generation-
skipping transfer, but the child's estate is not liable for the payment
of the tax. Instead, the tax would generally be paid out of the pro-
ceeds of the trust property. However, the trust would be entitled to
any unused portion of the estate tax credit for the child's estate, and
to the benefit of any increased marital deduction allowed to the estate
as a result of the transfer. In addition, the charitable deduction would
be allowable if part of the trust property were left to charity. The
previously taxed property credit would also be allowable where an
estate tax had been imposed with respect to the creation of the trust
and, within a 10-year period thereafter, the generation-skipping tax
is imposed upon the death of the child.
The provision requires that the tax be imposed whenever the child,
or other member of an intervening generation, had an income interest
in the trust, or a power to invade corpus for his own benefit. The tax
would not be imposed, however, where the child (as trustee for his
children, for example) had nothing more than a right of manage-
ment over the trust assets or a limited power of appointment among
grandchildren or more remote descendants of the grantor.
Also, under the provision, the tax would not be imposed in the case
of an outright transfer from a parent to a grandchild (because the
intervening generation receives no direct benefit from such a trans-
fer). Likewise, a trust established for the benefit of the grantor's
spouse. with the remainder outright to the grandchildren, would not
be subject to the tax because the intervening generation has no interest
in the trust. In addition (as a rule of administrative convenience),
tax would not be imposed in the case of distributions of accounting
income from a generation-skipping trust to a grandchild of the
grantor.
The tax under these rules would be imposed only once each gener-
ation. Generally, a generation would be determined along family lines,
where possible (i.e., the grantor, his wife, and his brothers and sisters
would be one generation; their children would be a second generation;
the grandchildren would be the third generation, etc.).
Where generation-skipping transfers are made outside the family,
generations would be measured from the grantor. Individuals not more






78


than 12 years younger than the grantor would be treated as mem-
bers of his generation; individuals more than 121/ years younger than
the grantor, but not more than 371/2 years younger, would be con-
sidered members of his children's generation, etc. In cases where
generation-skipping transfers are made outside the family, the deemed
transferor (that is, the base for purposes of determining the tax)
would be the estate of the person having the closest relationship to the
grantor or the person having the intervening life interest or power
(generally, the person named in the grantor's will or trust instrument).
In general, these provisions are to apply to generation-skipping
transfers which occur after April 30, 1977. However, under a tran-
sitional rule provided by the committee amendment, the tax is not to
be imposed for a 10-year period (until January 1, 1987) in the case
of transfers: (a) under irrevocable inter vivos trusts in existence on
April 30, 1977 (except to the extent that transfers are made from such
trusts out of assets added to the trust after April 30, 1977), or (b) in
the case of decedents dying before January 1, 1978, pursuant to a. will
(or revocable trust) which was in existence on May 1, 1977, and which
was not amended or revoked at any time after that date. The purpose
of this transition rule is to give beneficiaries under trusts which may
have been created in reliance on existing law a 10-year grace period
in which to relinquish their interests in the trust, if they wish to do
so, thereby eliminating the generation-skipping aspect of the trust
without liability for the tax imposed under these provisions (or for
gift tax in the event of such a relinquishment).
58. Gift Tax Treatment of Certain Annuities (see. 2203 of the bill)
Present law
For estate tax purposes, an exclusion is provided for the portion of
the value of a survivor benefit (e.g., an annuity) under a qualified re-
tirement plan that is attributable to contributions made by the em-
ployer. A parallel exclusion is provided for gift tax purposes.
In 1972, the estate tax provision was amended to ensure that no
portion of the employer contributions was includible in the gross estate
of the employee's spouse if the spouse predeceased the employee and
the couple had resided in a community property state. This amend-
ment was designed to overturn Rev. Rul. 67-278, 1967-2 C.B. 323,
which held that, if under community property laws the deceased
spouse had a vested interest in one-half of such contributions, this
half was includible in the spouse's gross estate and was not eligible
for the exclusion because the deceased spouse was not an employee
covered under the plan.
However, no corresponding amendment has been made to the gift
tax provisions. As a result, the IRS has ruled that, if an employee
predeceases his spouse in a community property State, the surviving
spouse is to be treated as having made a gift of one-half of any benefits
payable to other beneficiaries. Such a result would not occur in a non-
community property state.
Iss88ue
The issue is whether the gift tax provisions exempting interests in
qualified plans should have uniform application in both common law
and community property States regardless of which spouse (lies first.







Explanation of prot -ion
This provision was sponsored by Senator Packwood. The provision
permits a gift tax exclusion for the value, to the extent attributable to
employer contributions, or any interest of a spouse in specified em--
ployee contracts, or true or plan payments, where two conditions exist.
First, an employer must have made contributions or payments on
'behalf of an employee (or former employee) under an employee's
pension, stock bonus, or profit-sharing plan, or trust which is quali-
fied as an exempt plan for tax purposes (under section 401(a)), an
employee's qualified retirement annuity contract (covered under a
plan described in section 403(a)), or a retirement annuity contract
purchased for an employee by an employer which is an educational
organization (referred to in sec. 170(b) (1) (A) (ii)) or a publicly
supported educational, charitable, or religious organization (referred
to in sec. 170(b) (1) (A) (vi)). Second, the amount involved mist not
be considered as being attributable to contributions made by the em-
ployee. Where these two conditions exist, the value of the nonem-
ployee's interest would be excluded from taxable gifts to the extent the
value of that interest is attributable to the conditions of the employer
and to the extent the spouse's interest arises solely by reason of the
community property laws of the State.
This provision will have the effect of equating the gift tax treatment
in a community property State with that resulting upon the death of an
employee. The provision would also provide uniformity of treatment
in common law and community property States. The amount of bene-
fits payable to other beneficiaries which are attributable to the non-
employeee spouse's community interest in the value of the employer's
contribution to the plan would be excluded from such spouse's taxable
gifts for gift tax purposes.
This provision would not, in the case of the nonemployee spouse in
the community property State, provide any exclusion for a property
interest in the plan to the extent it is attributable to the contributions
of the employee spouse.
Thus, the nonemployee spouse's community interest in the plan
which is attributable to contributions made by the employee spouse
could be subject to the gift tax, as under present law.
The provision would apply to calendar quarters beginning after
December 31,1976.
The provision would benefit participants in qualified pension and
profit-sharing plans who live in community property States.
59. Outdoor Advertising Displays (sec. 2301 of the bill)
Present law
Under present law, gains from involuntary conversions of property
(including casualties and condemnations) are, in general, allowed non-
recoznition treatment where money realized from the involuntary con-
version is reinvested, within a limited period of time, in property
which is similar or related in service or use to the property converted
(sec. 1033). A special rule is provided for condemnations of business
or investment real estate (other than inventory property ) under which
more liberal rules are adopted for purposes of determining whether
a purchase of replacement real estate qualifies as similar or related
in service or use to the property converted (sec. 1033 (g)).






80


In the case of outdoor advertising billboards and displays, there is
some question whether this property qualifies as real property eligible
for the special replacement rules of section 1033(g). The Internal
Revenue Service has ruled that billboards are real property for pur-
poses of the investment credit and depreciation recapture.1 However,
this administrative interpretation has been successfully challenged in
several court cases which hold that billboards are tangible personal
property (and not real property) for purposes of the investment
credit.2
Issue
Federal and State highway beautification statutes authorize the
Government to condemn and purchase privately-owned highway bill-
boards. Because of continuing restrictions on where highway bill-
boards may be located, the former owners of condemned billboards
(particularly small companies) are prevented from using their con-
demnation awards to build and situate replacement billboards; these
taxpayers have been forced instead to reinvest their awards in other
types of real property. The present uncertainties in the property clas-
sification of billboards may prevent these reinvestments from qualify-
ing for treatment as involuntary conversion replacement property even
though the condemned billboards have consistently been treated by the
owners as real property.
Explanation of provision
This provision was sponsored by Senator Ribicoff. It establishes
an election for taxpayers to treat outdoor advertising displays as real
property. This election, once made, is irrevocable without the permis-
sion of the Secretary and it applies to all qualifying outdoor adver-
tising displays of the taxpayer. Outdoor advertising displays do not
qualify for the election where the taxpayer has previously treated the
property as tangible personal property by claiming' either the invest-
minent credit or additional first-year depreciation.
The provision also allows that replacement real property to be con-
sidered "like kind" property even though a taxpayer's interest in the
replacement property is different from the real property interest held
in a qualified outdoor advertising display which was involuntarily
converted. This is to enable, for example, purchases of replacement
property to qualify under section 1033(g) even though a fee simple
interest in real estate is acquired to replace in part a billboard owner's
leasehold interest in real property on which the billboard was located.
The election under the provision may be made for purposes of clas-
sifying replacements of qualifying outdoor advertising displays in tax-
able years beginning after 1970.
This provision applies generally to companies which have had bill-
board property condemned under the Highway Beautification Act.
Mr. Douglas Snarr has expressed an interest in this provision.
60. Interest on Certain Governmental Obligations for Hospital
Construction (sec. 2308 of the bill)
Present law
In general, industrial development bonds are not eligible for exemp-
tion from the Federal income tax on interest income. The term indus-
I Rpv. RuI. GR,-r,2. 1.9.q-1 C.B. 365.
2 Sv. e.z.. AlIhama Displayis, Inc. et al. v. unitedd Ptates. 507 F.2d R44 (Ct. C1. 1974) ;
Whiteco Indu1tries, Inc. et al. v. Commissioner, 65 T.C. No. 59 (1975).






81


trial development bond includes obligations from which all or a major
portion of the proceeds are used in a trade or business by a person
other than an exempt person. An exempt person is defined as a gov-
ernmental unit or an organization described in section 501 (c) (3) and
exempt from tax under section 501 (a), except for unrelated trade or
business activity.
Exceptions have been made for issues to finance certain facilities
which possess elements of a public character and for the develop-
ment costs of industrial parks. In addition, an exemption also is pro-
vided for certain small issues which do not exceed $5 million. The
exempt activities of a public character include providing residential
real property for families, sports facilities, convention or trade show
facilities, certain freight and passenger transportation facilitieF, pol-
lution control or waste disposal facilities, and certain local public
utility facilities.
Public hospitals operated by governmental units may be financed
with tax-exempt bonds, but private hospitals are not eligible for
financing with industrial development bonds except under the small
issues exemption.
Issue
The costs of constructing and equipping hospitals have increased
rapidly in the past several years, and the committee was told, it is not
possible now to construct a moderate-sized private hospital within
the $5 million limitation. This is a matter of importance in rural areas
where public hospitals have not been built.
The issue is whether there should be an exemption from the limita-
tion under present law to permit the issue of tax-exempt bonds for
private hospitals.
Expla nation of provision
This provision was sponsored by Senator Bentsen.
The provision adds a special exception from the $5 million limit
for small issues which will permit issues up to $20 million for a pri-
vate hospital which is certified as necessary by the appropriate State
health agency.
The provision is effective for obligations issued in taxable years
beginning after December 31,1976.
Revenue effect
It is estimated that this provision will decrease budget receipts by
$1 million in fiscal year 1977, $3 million in fiscal year 1978, and $14
million in fiscal year 1981.
61. Group Legal Services Plans (sec. 2309 of the bill)
Present law
Prepaid group legal services plans are a recent, innovative means of
providing legal services. Because of the relative novelty of these fringe
benefit plans and the variety of their design, the tax treatment of the
employer contributions on behalf of the employee and of the benefits
received by the employee under such plans has not yet been clearly
established.
However, depending on the structure of the plan, it appears that
the employee will be required to include in his income either (1) his





82


share of the amounts contributed by his employer to the group legal
services plan or (2) the value of legal services or reimbursement of
expenses for legal services received under the employer-funded plan,
or both. (If plans are funded with contributions which are partially
taxable and partially tax-free to the employee, the employee may be
required to include any benefits in income to the extent the contribu-
tions for the plan constitute amounts not previously included in the
employee's income.)
Amounts contributed by the employer for an employee to a group
legal services plan or the value of services or reimbursements if pro-
vided directly by the employer to the employee under a plan are de-
ductible by the employer as ordinary and necessary business expenses,
if they meet the usual standards for trade or business deductions.
Issue
The issue is whether it is necessary or appropriate to provide a tax
incentive to promote prepaid legal services plans.
Explanation of provision
This provision was sponsored by Senator Packwood. The
provision excludes from an employee's income amounts con-
tributed by an employer to a qualified group legal services plan for
employees (or their spouses or dependents)as well as any services
received by an employee or any amounts paid to an employee under
such a plan as reimbursement for legal services for the employee, his
spouse, or his dependents. The exclusion does not apply to direct
reimbursements made by the employer to the employee. There is no
corresponding provision in the House bill.
In order to be a qualified plan under which employees are entitled
tote the tax-free benefits provided by the amendment, a group legal
services plan must fulfill several requirements with regard to its pro-
visions, the employer, and the covered employees. These requirements
are designed to insure that the tax-free fringe benefits are provided
on a nondiscriminatory basis with regard to contributions and bene-
fits, as well as eligibility for enrollment, and to minimize the possi-
bility of tax abuse through the misuse of such plans. Additional
requirements include provisions for a written plan, notice to employees
about benefits, contribution arrangements, IRS administration, the
treatment of existing plans, and definitions and rules for partnerships
and proprietorships, as well as corporations.
The provision also permits a trust created or organized in the
United States, whose exclusive function is to form part of a qualified
group legal services plan, to be exempt from income tax (new sec.
501(e) (20)). Such a trust is to be subject to the rules governing
organizations exempt under section 501(c), including the taxation
of any unrelated business income.
Le.rislation excluding employer contributions and benefits provided
to employees under group legal services plans has been requested by
the Lahoreris' International Union of North America. AFL-CIO, and
the Natio'.l. Ccnmsuner Center for Legal Services, Washington, D.C.
The American B.r Association has also urged the adoption of a tax
incentive for group legal services plans.





83


Effective date
This provision applies to taxable years beginning after December 31,
1973. Existing plans are allowed a transition period, in some cases ex-
tending through 1981, to conform to the requirements contained in
this provision.
Revenue estimate
It is estimated that this provision will decrease budget receipts by
$5 million for fiscal year 1977, $8 million for fiscal year 1978, and $33
million for fiscal year 1981 (and this revenue loss will continue to
increase significantly thereafter).
62. Exchange Funds (sec. 2310 of the bill)
Pre.sett law
An exchange fund is an investment entity through which large
numbers of investors pool stocks or debt securities which usually are
highly appreciated in exchange for shares of the fund. These arrange-
ments allow investors to diversify their concentrated ownership of
one or a few securities into a broader variety of other stocks and
securities (usually publicly-traded interests in listed companies)
without paying taxes on the appreciation they have realized, in effect,
at the time the different stock interests are exchanged for each other.
Present law does not permit tqx-free formation of an exchange fund
as a corporation where the result is a diversification of the investor's
portfolio. This restriction was added in 1966 after a period in the
early 1960's when investment management firms publicly solicited
individuals own^i" highly appreciated stocks or securities to pool
their stocks tax-free in a newly formed corporation which would then
manage the combined portfolio.
The 1966 legislation dealt only with swap funds in corporate form
and did not deal with partnerships because at that time such funds
could not operate in partnership form. Recently, however, a number of
public syndications have been organized to sell exchange funds as
partnership interests. In April, 1975, the Internal Revenue Service
granted a private ruling to one fund which proposed to operate as a
limited partnership, allowing investors to transfer appreciated stocks
or securities to the fund without a current tax to the inve.tor-limited
partners. This ruling prompted the formation of other similar part-
nerships, including some which proposed to offer interests to investors
privately( rather than by broad public solicitation). Several of these
funds presently have ruling requests pending with the Service.
Issue
One tax issue raised by the appearance of exchange funds in part-
nership form is whether a tax-free diversification of stock investments
should be permitted through use of the partnership form when the
same result cannot be achieved, under present law, through a corpora-
tion or through a direct exchange of portfolio stocks for other similar
stocks.
Another issue is whether the tax advantages of an exchange fund
(namely, no tax to the investor on his appreciation at the time his
stock is pooled with others and taxfree diversification of his invest-


74-375-76--7






84


nment assets) should be available through other forms, such asa trust,
common trust fund, or a corporate reorganization.
Explanation of provisions
The House, on May 3, 1976, passed H.R. 11920 which deals with the
tax treatment of partnership exchange funds and mergers of certain
investment companies (generally mergers of personal holding com-
panies with mutual funds), where a taxpayer's principal interest is
to diversify his investments without current payment of any tax. In
general, the House bill conforms the partnership tax rules to those for
corporations in the case of exchange funds and, as a result, makes tax-
able the transfer of appreciated stocks or securities (as well as other
property) to a partnership if, as a result, the transferor' investment
interests are diversified.
Senator Bentsen sponsored the addition of the House-passed bill
(H.R. 11920) to the Tax Reform Bill. Senator Talmadge sponsored
the extension of the transitional rule in the House-passed bill from
February 17, 1976, to March 26, 1976, the day before the House Com-
mittee on Ways and Means held hearings on the bill.
Partnership exchange funds
The committee amendment adopts the House-passed bill to
treat the original exchange of appreciated stocks for shares
of a swap fund as a taxable sale or exchange with other investors
made through the fund. Thus, the committee amendment is essentially
the same as the provisions of H.R. 11920, with certain modifications.
Family padinerships.-The provision adds an exception to the part-
nership rules of H.R. 11920, as passed by the House, for certain family
partnerships. This was a suggestion made by the staff. Where stocks
(or other property) are pooled within a single family group, the
basic problems against which the partnership rules in the provision
are directed give less reason for concern. The provision accordingly
provides that property can continue to be transferred to a partnership
tax free (in exchange for an interest in the partnership) if certain
requirements are met. Thus, under this rule a family group may share
the income from a pool of stocks so long. as each contributing partner
in effect bears the tax on the built-in gain which existed at the time he
contributed that property to the folio.
Effective date.-The provisions for partnership exchange funds ap-
ply generally to transfers made to a partnership after February 17,
1976.
The House bill added "grandfather" rules for certain funds under
which the general effective date would not apply to completed transfers
of property to a partnership after February 17,1976, if several condi-
tions are satisfied. First. the partnership must have filed for (or re-
ceived) a private ruling from the Internal Revenue Service on or before
February 17, 1976, relating to its character as an exchange fund.
S second. the partnership) must have filed a registration statement (if
required by the semirities laws to do so) with the Securities and Ex-
change Commission on or l)efore February 17, 1976.1
1 This i eond requirement would not Ppply in the ease of partner.iph. whiich plan to
make a private offering within the melanin of tit" spcuritles laws or whichli otherwise are
not rpqiired to file a registration statement with the SEC.






85


The provision covers also several other exchange funds which had
taken significant steps toward being formed before the Febru-
ary 17 date contained in the House bill,but, at that time, had not filed a
tax ruling request or a registration statement with the Securities and
Exchange Commission. The committee was informed that the reason
was that there was a great deal of uncertainty over the status of the
law, and informal contacts with Internal Revenue Service personnel
indicated that the rulings would not be acted on until the Service's po-
sit ion in this area was clarified. As a result, these funds did not file their
ruling requests or registration statements by February 17, 1976, al-
though they had expended considerable sums of money and time in
preparing for the organization of their fund, having been aware of the
previous private ruling issued to the Vance Sanders Fund. The pro-
vision extends the date provided in the House bill until the time the
House Committee on Ways and Means held hearings on its bill. Ac-
cordingly, the provision extends the cutoff date under the grandfather
rules to March 26, 1976. In addition, in lieu of the dual conditions for
grandfather treatment, the committee amendment imposes conditions
in the alternative, so that a fund can qualify for grandfather treatment
if it either filed a ruling request with the Service or a registration
statement with the Securities and Exchange Commission before
March 27,1976.
The transitional provision provided in the House bill covers the
following partnership exchange funds: Vance Sanders, State Street,
Fidelity, American General, and Boston Company Exchange Associ-
ates. The extension of the transitional date from February 17, 1976,
to March 26, 1976. covers the following additional exchange funds:
Chestnut Street and Equity.
Trqs ts~
In order to cover the possible use in the future of trusts as exchange
funds, the provision also adds a specific rule to the Code that gain
(but not loss) will be recognized to the transferor on a transfer of
property to a trust in exchange for an interest in other trust property
where the trust would be 'an "investment company" (within the mean-
ing of sec. 351) if the trust were a corporation. This is the same as the
House bill.
Common trust funds
To cover the possible use of a bank's common trust fund as an ex-
change fund, the amendment provides that the admission of a par-
ticipant to a common trust fund is to be considered to be the purchase
of, or an exchange for, the participating interest in the fund. As a
result, gain or loss will be realized by the participant on any transfer
of property to the common trust fund. This is the same as the House
bill.
Mergers of tro or more inre.I.tent compnpo;s
The provision adds an exception to the definition of a taxfree "re-
org2anization" in present law in order to require recognition of gain or
loss on exchanges which, from an investor's standpoint, resemble the
formation of an exchange fund. This exception is provided in specific
terms in order not to change the application of the reorganization rules
to transactions other than those which enable investors to obtain the
primary advantages of an exchange fund. This is the same as the
Hou-e bill.





86


Revenue effect
It is estimated that these provisions will increase budget receipts by
less than $5 million in fiscal years 1977 and 1978 and increase budget
receipts by $12 million in fiscal year 1981.
63. Special Credit for Wind-Related Energy Equipment (sec.
2505 of the bill)
Present 7awo
Under present law, no special tax credit or deduction is allowed for
wind-related energy equipment (such as a traditional windmill) in-
stalled with respect to a residence.
However, a 10-percent investment credit is permitted for the capital
costs of several types of business machinery, equipment, and facilities
used in a trade or business or held for the production of income. As a
facility used as an integral part of the production of electrical energy,
wind-rielated energy equipment used to generate electricity may be
entitled to the investment credit of present law (sec. 48(a) (1) (B) (i)),
unless it is a structural component of a building.
Issue
The issue is whether a tax credit should be, provided for the installa-
tion of wind-related energy equipment to provide energy for certain
residential and commercial uses.
Explanation of provlsin
This provision was sponsored by Senator Hathaway.
The provision establishes a refundable income tax credit for wind-
related energy equipment installed on or adjacent to a residence. Like
the solar and geothermal equipment credits, the credit for wind-related
energy equipment is 40 percent of the first $1,000 of qualified expendi-
tures, plus 25 percent of the next $6,400 (a maximum credit of $2,000).
To qualify, both the equipment and its installation-must be paid for
by the individual (or individuals) usingthe edifice as a residence. Thus,
the owner or a tenant may qualify, but a builder or developer adding
the wind-related equipment to a house he does not intend to use as his
residence would not qualify for this credit (although he might qualify
for the investment credit given under this amendment for wind-related
energy equipment installed for commercial or industrial purposes).
This tax credit is to be allowed only for installations and expendi-
tures made, or, in the case of an accrual basis taxpayer, incurred,
through 1980. Before that time, the committee will review the credit
to see whether it should be continued after 1980. Also, both the instal-
lation and the expenditure must occur after June 30, 1976. The credit
is for-both the expenditures for wind-related equipment itself and also
for expenditures for its installation.
The wind-related energy equipment for which the credit may be
claimed is that which uses wind-related energy to generate electricity
to heat or cool a r.,oiOence (or residences) or to provide hot water for
use inside it, and (1) which meets such standards or criteria for per-
formance as the Secretary of Housing and Urban Development may
prescribe, (2) the original use of which commences with the taxpayer,
and (3) which has a useful life of at least three years.
The wind-related energy equipment credit is a refundable credit. As
a result, a taxpayer whose tax liability is less than the amount of the






87


credit would receive a refund of the difference, while the amount of
his credit that equals the amount of his tax liability would be avail-
able to eliminate that liability.
The Committee amendment extends the investment credit (at an
increased rate for a limited period of time) to wind-related energy
equipment (such as windmills) installed for use in the trade or busi-
ness of producing electricity or to generate electricity for use in a
trade or business. The amount of the credit is to be 20 percent of the
qualified wind-related energy equipment installation investment after
May 25, 1976, and before January 1, 19S2. After that time, the credit
is reduced to 10 percent for this type of investment through 1986. Both
the 20-percent and the 10-percent, credits apply to the costs of the wind-
related energy equipment itself, as well as the costs of its installation.
This provision will benefit purchasers and manufacturers of wind-
mills. Researchers at the Univer-:ity of Maine, among others, have
expressed interest in it.
64. Income Earned Abroad by U.S. Citizens Living or Residing
Abroad (sec. 2503 of the bill)
Present t law aund committee am e.i dinment
U.S. citizens who are working a hroad nmav exclude (under section
911) income up to $20,000 of earned income for periods during which
they are present in a foreign country for 17 out of 18 months, or
during the period they are bona fide residents of foreign countries. In
the case of individuals who have been bona fide residents of foreign
countries for three years or more, the exclusion is increased to $25,000
of earned income.
The provision retains the exclusion for certain earned income of
individuals abroad but makes three modifications in the computation
of the exclusion. First, it provides, as did the House bill, that any
individual entitled to the earned income exclusion is not to be allowed
a foreign tax credit with respect to foreign taxes allocable to the
amounts that are excluded from gross income under the earned income
exclusion. Thus, foreign income taxes that are paid on excluded
amounts are not to be creditable or deductible.
Second, it provides that any additional income derived by individ-
uals beyond the income eligible for the earned income exclusion is
subject to U.S. tax at the higher rate brackets which would apply
if the excluded earned income were not so excluded. For the purpose of
determining the rate brackets applicable to the nonexcluded income,
the taxpayer is entitled to subtract those deductions which would
1be otherwise disallowed by reason of being allocable to the excluded
earned income.
Since earned income is now subject to an exclusion with the other
income being taxed at the higher brackets; any foreign tax credits dis-
allowed by reason of being allocable to the excluded earned income are
to be considered as those taxes paid on the first $20,000 or $25,000 of
excluded income. For this purpose, the same rate of progressiveness
is to be assumed on the foreign taxes as is the case for the U.S. taxes.
Third, the amendment makes ineligible for the exclusion any income
earned abroad which is received outside of the country in which earned
if one of the purposes of receiving such income outside of the country
is to avoid tax in that country. The tax avoidance purpose does not have





88


to be the only purpose for receiving the money outside of the country
in which earned, nor does it have to be the principal reason for receiv-
ing the money outside of that country.
Issue
Under the committee amendment, individuals who derive earned
income in a foreign country which is taxed by that foreign country
under a progressive rate system which is higher than the progressive
rate system in the United States have excess foreign tax credits on
their excluded earned income. These individuals are better off without
the earned income exclusion, since they would then be able to use
their excess credits against other foreign source income which they
may derive. The issue is whether these individuals should be entitled
to an election not to apply any earned income exclusion.
Explanation of provision
This provision was sponsored by Senator Fannin. The provision
allows an individual to elect (in such manner and time as the Secretary
of the Treasury prescribes) not to have the earned income exclusion
apply. If an individual makes the election for a taxable year, the elec-
tion is binding for all subsequent taxable years and may not be revoked
except with the consent of the Secretary. This provision will benefit
the Paris office of the law firm of Surrey, Karasik and Morse and'
members of the National Constructors Association.
65. Level Premium Annuity Contracts Held by H.R. 10 Plans
(sec. 2508 of the bill)
Present law
Under present law, if an owner-employee 1 is covered by a tax-
qualified plan (an "H.. 10 plan"), the employer is not permitted to
contribute to the plan more than $7,500 or 15 percent (whichever is
less) of the owner-employee's earned income (secs. 401 (d) (5) and 404
(e)). If the plan is funded with level premium annuity contracts,
under which a fixed premium of $7,500 or less is paid without regard
to the owner-employee's earnings, present law dealing specifically with
H.R. 10 plans (1) permits contributions to be made to the plan in an
amount sufficient to pay the premiums on the contract (subject to the
requirement that the premium not exceed the owner-employee's aver-
age deductible amounts for a 3-year period), but (2) does not allow a
deduction for amounts contributed for the owner-employee in excess
of 15 percent of his earned income (sees. 401 (d) (5), 401 (e), and 404
(e)). However, under a separate provision which provides overall
limitations on contributions to all qualified plans (sec. 415), the con-
tributions on behalf of an owner-employee cannot exceed 25 percent of
his earned income. (That provision is modified, in the case of certain
lower-income owner-employees, by another provision in this bill-sec.
1503 of the bill as reported by the committee, the so called "jockeys
amendment".)
1 An owner-employee is an employee who owns the entire Interest In an unincorporated'
trade or business or, in the case of a partnership, is a partner who owns more than 10,
percent of either the capital interest or the profits interest in that partnership (sec. 401.
(c) (3)).





89


Issue
The issue is whether the 25 percent rule should be modified to pen :i it
H.R. 10 plans to continue in their present form.
Explanation of provision
This provision was sponsored by Senator Bentsen.
The provision permits contributions to be made to an H.R. 10 plan
on behalf of an owner-employee under annuity contracts despite the
overall 25-percent limitation if no other amounts are added to his
account for the year under any other defined contribution plan or tax-
sheltered annuity maintained by the employer or a related employer
and if the employee is not an active participant for the year in a
defined benefit plan maintained by the employer or a related employer.
Under the amendment, the overall limitations which apply where- an
employee participates in both a defined contribution plan and a defined
benefit plan are not changed.
The provision applies for years beginning after December 31,1975,
the effective date of the overall limitations.
66. Unrelated Business Income of Tax-Exempt Hospitals (sec.
2509 of the bill)
Present law
Present law (sees. 511 through 514) imposes a tax on the unrelated
business income of most exempt organizations, including hospitals
which are exempt under section 501 (c) (3) (relating to orgamniza-
tions organized and operated for religious, charitable, scientific, edu-
cational, etc. purposes). The term "unrelated trade or business" is
defined (sec. 513) as any trade or businc-s the conduct of which is not
substantially related (aside from the need of such organization for
income or funds or the use it makes of the profits derived) to the
exercise or performance by such organization of any religious charit-
able, scientific, educational, etc., purpose. In Rev. Rul. 69-633, 1969-2
C.B. 121, the Internal Revenue Service ruled that income which a tax-
exempt hospital derives from providing laundry sorviees to other tax-
exempt hospitals constitutes unrelated business taxable income to the
hospital providing the services, since the providing of services to other
hospitals is not substantially related to the exempt purposes of the,
hospital providing the services.
Issue
The issue is whether one tax-exempt hospital should be permitted
to provide certain services to other tax-exempt hospitals without tax.
Explanation of provision
This provision was included at the suggestion of Senator Curti-.
The provision establishes that a hospital is not engaged in an unre-
lated trade or business simply because it provides services to other
hospitals if those services could have been provided, on a tax-free basis,
by a cooperative organization consisting of several tax-exempt hos-
pitals. The exclusion from the unrelated business tax applies only
where the services are provided only to other tax-exempt hospitals,
each one of which has facilities to serve not more than 100 inpatients,






90


and (2) the services would be consistent with the recipient hospital's
exempt purpose.
The provision will benefit hospitals generally which engage in coop-
erative efforts with other exempt hospitals.
Effective date
This provision applies to all "open" taxable years to which the In-
ternal Revenue Code of 1954 applies.
67. Hospital Laundry Facilities (sec. 2509 of the bill)
Present law
Under present law (sec. 501(e)), certain cooperatively-operated
service organizations which have been created by tax-exempt hospitals
are also considered to be tax-exempt charitable organizations. In
order to qualify for that tax-exempt status, a hospital service or-
ganization (1) must be organized and operated solely to perform cer-
tain specified services which, if performed directly by a tax-exempt
hospital, would constitute activities in the exercise or performance of
the purpose or function constituting the basis for its exemption, and
(2) must perform these services solely for two or more tax-exempt
hospitals. That provision does not apply to organizations which per-
form services other than those listed in the statute, such as laundry
services. (See H. Rept. 1533, 90th Cong., 2d Sess.) In Rev. Rul. 69-633,
1969-2 C.B. 121, the Internal Rovenmie Service ruled that a coopera-
tively-operated organization performing laundry facilities for various
tPx-evempt hospitals is not exempt under that provision, but may
qualify for tax treatment as a cooperative under sections 1381 to 1383
of the Code.
Issue
The issue is whether tax-exempt hospitals should be permitted to
provide laundry and clinical services to themselves without tax through
a cooperatively organized and operated service organization.
Explanation of provi.sion
This provision waf snonsorpd by Senator Ribicoff.
The provision adds the performance of laundry and clinical services
to the types of services that can be performed on a cooperative basis
byV tax-exempt hospitals. This. it is permissible for tax-exempt hos-
pitals to create a cooperative service organization to provide laundry
and clinical facilities to these hospitals.
The provision is effective for taxable years ending after Decem-
ber 31,1976.
This provision was ug'edl by the American Hospital Ascociation.
68. Certain Charitable Contributions of Inventory (sec. 2511 of the
bill)
Present law
Under present law (sec. 170 (e)), a taxpayer who makes a charitable
contribution of property must reduce the amount of tihe deduction
(from fair market value) by the amount of ordinary gain he would
hnve realized had the property been sold instead of donated to charity.
(fnder certain circumstances, a taxpayer may have to reduce the
amount of his charitable contribution by a portion of the capital gain





m91


he would have received if the property had been sold.) Thus, the donor
of appreciated ordinary income property (property the sale of which
would not give rise to long-term capital gain) may deduct only his
basis in the property rather than its full fair market value.
When this rule was added to the Code in 1969, it was intended, in
part, to prevent the abuse situations in which taxpayers in high mar-
ginal tax brackets and corporations could donate to charity substan-
tially appreciated ordinary income property and actually be better
off, after tax, than they would have been if they had sold the proper-
ties and retained all the after-tax proceeds of the sales.
The rules requiring that the donor of appreciated ordinary income
property can deduct only his basis in the property have effectively
eliminated the abuses which led to their enactment; however, at the
same time, they have reduced contributions of certain types of prop-
erty to charitable institutions. In particular, those charitable organiza-
tions that provide food, clothing, medical equipment and supplies,
etc., to the needy and disaster victims have found that contributions
of such items to those organizations have been reduced.
Issue
The issue is whether it is desirable to provide a greater tax incentive
than in present law for contributions of certain types of ordinary
income property which the donee charity uses in the performance of
its exempt purpose so long as the donor could not be in a better after-
tax situation by donating the property than by selling it.
Explanation of prov/;..'oi
This provision was included at the suggestion of Senator Ribicoff.
The provision allows a corporation (other than a subchapter S
corporation) a deduction for up to half of the appreciation on certain
types of ordinary income property contributed to a public charity
or a private operating foundation.
In ord(ler to qualify for this treatment, the following condition- mii,-t
be satisfied: (1) the donee must use the property (a) in a use related
to its exempt purpose and (b) solely for the care of the ill, the needy,
or infants; (2) the donee must not transfer the property in exchange
for money, other property, or services: and (3) the donor must receive
a statement from the donee representing that its use and disposition
of the property will comply with requirements (1) and (2) above.
If all these conditions are complied with, the charitable deduction
will generally be for the sum of (1) the taxpayer's basis in the prop-
erty and (2) one-half of the unrealized appreciation. However, in no
event is a deduction to be allowed for an amount which exceeds twice
the basis of the property. Furthermore, no deduction is to be allowed
for any part of the unrealized appreciation which would have been
ordinary income (if the property had been sold) because of the appli-
cation of the recapture provisions relating to depreciation, certain
mining exploration expenditures, certain excess form losses. certain
soil and water conservation expenditures, and certain land clearing
expenditures.
This provision applies to charitable contributions'made after the
date of the bill's enactment.
CARE and the American Council of Voluntary Agencies for For-
eign Services, Inc., have expressed an interest in this provision.






92

Revenue estimate
It is estimated that this provision will result in a reduction in cor-
porate tax liability of $16 million in fiscal year 1977, $22 million in
fiscal year 1978, and $2-14 million in fiscal year 1981.
69. Tax Liens, Etc., Not to Constitute "Acquisition Indebtedness"
(sec. 2513 of the bill)
Present law
Generally, an organization which is exempt from Federal income
tax under section 501(a) is taxed only on income from trades or busi-
it is not taxed on passive investment income and income from any trade
or business which is related to the organization's exempt purposes.1
Before 1969, some exempt organizations had used their tax-exempt
status to acquire businesses through debt financing, with purchase
money obligations to be repaid out of tax-exempt profits, such as from
leasing the assets of acquired business to the business' former owners.
The Tax Reform Act of 1969 included the so-called "Clay Brown
provision"' which provides that an exempt organization's income from
"debt-financed property" which is unrelated to its exempt fllunction,
is to be subject to tax in the proportion in which the property is fi-
nanced by the debt. In general, debt-finmanced property is defined as
"any property which is held to produce income and with respect to
which there is acquisition indebtedness". Acquisition indebtedness
exists with respect to property whenever the indebtedness was incurred
in acquiring or improving the property, or the indebtedness would not
have been incurred "but for" the acquisition or improvement of the
property.2
Where property is acquired subject to a "mortgage or other similar
lien." the debt secured by that lien is generally considered acquisition
indebtedness. The Treasury Regulations (Regs. 1.514(c)-1(b) (2))
provide, in effect, a special rule for debts for the payment of taxes. The
regulations provide, in part, as follows: "[I]n the case where State law
provides that a tax lien attaches to property prior to the time when
such lien becomes due and payable, such lien shall not be treated as
similar to a mortgage until after it has become due and payable and
the organization has had an opportunity to pay such lien in accordance
with State law."
There is no similar exception for State or local governments' spe-
cial assessments to finance improvements.
It is common practice for State and local governmental units in some
States to undertake certain improvements to land, such as roads, curbs,
gutters, sewer systems, etc., and to finance these improvements either
throTugh its general tax revenues or special assessments imposed on
1 Tl.pre are some exceptions to the general rule that passive investment income is tax-
exempt. For example, social clubs (sec. 501(c)(7)) and voluntary employees' beneficiary
associations (sec. 501(c) (9)) are generally taxed on such income. Also, private founda-
tions are subject to an excise tax of 4 percent (which the bill, as amended by the commit-
tee, lowers to 2 percent) on their net investment income (sec. 4941). An additional
excntion relates to debt-financed income (sec. 514), described below.
2 There are several exceptions from the term acquisition indebtedness. For Instance, one
exception is indebtedness on property which an exempt organization receives by 'devise,
l.Pqiie!-t, or, under certain conditions, by gift. This exception allows the organizations re-
ceivinz the property to have a 10-year period of time within which to dispose of it free
o" tax under this provision, or to retain the property and reduce or discharge the indebted-
ness on it with tax-free Income. Also, the term. "acquisition indebtedness" does not include
indebtedness which was necessarily Incurred in the performance or exercise of the purpose
or function constituting the basis of the organization's exemption. Special exceptions are
also provided for the sale of annuities and for debts insured by the Federal Housing Admin-
istration to finance low and moderate-income housing.





93


the land which the improvements are intended to benefit. The imme-
diate funds for the improvements are provided by the sale of bonds
sccrcd by liens on the land. The bonds are then paid off either through
the general tax revenues or the special assessments over a period of
years.
The Internal Revenue Service has taken the position that if a lien
arises from a special as--ssinent of the type described above, as op-
posed to a property tax lien, the lien securing the installment pay-
ments of the assessment will constitute acquisition indebtedness, even
though the installment payments are due in future periods.
18 Issue
It is argued that the indebtedness arising from a special assessment
of this sort does not appear to be the type of indebtedness that the debt-
financed property provisions were intended to deal with in the
1969 Act.
The issue is whether this type of indebtedness should be treated as
acquisition indebtedness.
Explanation of pro ';.sion
This provision was sponsored by Senator Gravel. Under the pro-
vision, the indebtedness with respect to which a lien arising from
taxes or a lien for special assessments made by a State or an instru-
mentality or a subdivision of a State is not to be acquisition indebted-
ness until, and to the extent that, an amount secured by the lien
becomes due and payable and the exempt organization has had an
.opportunity to pay the the taxes or special assessment in accordance
with the State law.3 However, it is not intended that this provision
apply to special assessments for improvements which are not of a type
normally made by a State or local governmental unit or instrumentality
in circumstances in which the use of the special assessment is essen-
tially a device for financing improvements to an exempt organization's
property.
In determining when a lien becomes due and payable and the ex-
.empt organization has had an opportunity to pay the necessary amount
in accordance with State law, it is intended that consideration is to be
given to the realities of the situation, and not merely the formal recita-
tions of State law. For example, Hawaii law (sec. 67-23) provides that
special assessment become "due and payable" at the end of a des-
ignated 30-day period. However, a failure to pay the assessment at
the end of that period constitutes, under State law, an election to pay
the assessment in installments (see. 67-23; see sec. 67-25). Sanctions are
then provided (sees. 67-27 and 67-29) in the event of failure to pay
the installments when due. In such a situation, the assessment, lien
is to be treated as becoming due and payable only at the time when
the relevant installment is required to be paid.
This provision was requested by the Bishop Estate. It has potential
application throughout the nation.
Since this amendment is intended to reflect the intent of Congress
when it amended section 514 in 1969, the amendment is to apply to all
taxable years beginning after December 31, 1969.
3 This amendment is intended to apply also to the definition of business-lease indebt-
n&--,. in section 541(g). However, since that provision is proposed to be repealed by the
committee amendment, no statutory amendment is made to it.





94

Re venue estimate
It is estimated that this provision will result in a decrease in
budget receipts of less than $5 million annually.
70. Extension of Private Foundation Transition Rule for Sale of
Business Holdings (sec. 2514 of the bill)
Present law
The Tax Reform Act of 10969 imposed taxes upon certain trans-
actions between a private foundation and its "disqualified persons"'
(generally, persons with an economic or managerial interest in the op-
eration of that foundation). Among the transactions to which these
taxes on "self-dealing" apply are the sale, exchange, or leasing of
property (sec. 4941). The 1969 Act also added a provision which limits
the combined ownership of a business enterprise by a private founda-
tion and all disqualified persons and taxes any excess holdings which
are not divested within a specified period of time (sec. 4943).
A transitional rule provided in the 1969 Act permits a private foun-
dation to sell excess business holdings to a disqualified person if the
sales price equals or exceeds the fair market value of the property
being sold. This transitional rule was generally intended to allow
private foundations and( disqualified persons to disentangle their affairs
and which was based on recognition of the fact that for many closely-
held companies the only ready market for a private foundations
holdings would be disqualified persons; in general it permits the
sale of such excess business holdings within the transitional
period during which the holdings would be permitted holdings. How-
ever, this transitional rule (see. 101(1) (2) (B) of the 1969 Act) also
provides that if the other requirements of the transition rule were satis-
fied, prior to January 1, 1975. a private foundation could have sold
certain business holdings (which would have betn. excess business
holdings but for the transitional and "grandfather" rules of sec-
tion 4943) to disqualified persons even if those holdings were not,
and would not become, excess business holdings (under sec. 4943).
Issue
The issue is whether it is desirable to provide a further transi-
tional period for private foundations to divert themselves of certain
"nonexcess" holdings in enterprises in which disqualified persons
have a significant interest, if the foundation receives fair market
value for such business holdings.
Explanatio. of priov 's;on
This provision was sponsored by Senator Fannin. The provision
exterids the effective date of a private foundation transitional rule
in the Tax Reform Act of 1969 (sec. 101(1) (2) (B)) so that the
transitional rule, will apply to a sale, exchange, or other disposition
of certain "nonexcess" business holdings which tables place before
Janmunry 1, 1977. This exten-ion does not effect any of the other re-
q(llirements of section 101(1) (2)(B). Therefore, for example, the
requirements that such a disposition is allowed only as to property
which is owned by a priv-ate foundation on May 26. 1969 (or which
is considered as having been owned by a private foundation on
that d(late), and the requirement that the foundation receive at least
fair market value for the property, are not affected by this provision.