Tax reform act of 1976, H.R. 10612


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Tax reform act of 1976, H.R. 10612 testimony to be received Thursday, July 22, 1976, and additional administration views
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Committee on Finance, United States Senate, Russell B. Long, chairman, July, 1976.
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At head of title: 94th Congress, 2d session. Committee print.
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Full Text

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2d Sessions

TAX REFORM ACT OF 1976 H.R. 10612


Additional Administration Views


JULY 1976

Printed for the use of the Committee on Finance


RUSSELL B. LONG, Louisiana, Chairman HERMAN E. TALMADGE, Georgia CARL T. CURTIS, Nebraska
HARRY F. BYRD, JR., Virginia ROBERT DOLE, Kansas



Ad Hoc Committee for Equitable Tax Treatment of the Publishing Industry Page
and the Association of American Publishers, Townsend Hoopes ----------39 Aetna Life & Casualty Co., John H. Filer, chairman-------------------- 27
Allen, Hon. James B., a U.S. Senator from the State of Alabama ----------1
American Bankers Association, D~aniel L. Davis------------------------ 75
American Council of Life Insurance, Blake T. Newton, Jr., presiden --- 149 American Gas Association, Richard A. Rosan -------------------------- 137
American General Capital Management, Inc., John E. Chapoton -----------323
American Hospital Association, Leo J. Gehrig, M.D., senior vice president- 375 American Totel '& Motel Association and the National Restaurant Association ------------------------------------------------------------- 69
American Livestock Show and Rodeo Managers' Association, Kenneth H.
Liles----------------------------------------------------------- 265
American Society of Association Executives, James P. Low, president and chief administrative officer ---------------------------------------- 271
Association of American Publishers and the Ad Hoc Committee for Equitable Tax Treatment of the Publishing Industry, Townsend Hoopes---- 39 Association of American Railroads, John P. Fishwick, president and chief
executive officer, Norfolk & Western Railway Co., and James H. Evans,
vice chairman, Union Pacific Railroad ------------------------------- 165
Association of Art Museum Directors, Kenneth H. Liles, of Sutherland,
Asbill & Brennan------------------------------------------------- 285
Association of Closed-End Investment Companies, W. David MacCallan, director--------------------------------------------------------- 143
Authors League of America, Irwin Karp, counsel----------------------- 51
Badger Meter, Inc-------------------------------------------------- 33
Barrett, Richard F., for Stackpole-Hall Foundation -------------------- 243
Belco Petroleum Corp., Robert A. Belfer, president --------------------- 123
Belfer, Robert A., president, Belco Petroleum Corp ---------------------- 123
Biegel, Herman C-------------------------------------------------- 159
Bradley, John A., president, Federation of American Hospitals ----------- 287
Butt, Sheldon H., president, Solar Energy Industries Association ----------13
Carter, Thomas S., president, Kansas City Southern Railway Co,----------183
Chapoton, John E., for:
Domestic Wildcatters Association------------------------ --------- 85
American General Capital Management, Inc.; Boston Company Exchange Associates; Fidelity Exchange Fund; and State Street Exchange Fund------------------------------------------------ 323
Cohen, Edwin S ---------------------------------------------------- 159
Davis, Daniel L., for the American Bankers Association ------------------75
Dement, Sandy, executive direct-or, National Consumer Center for Legal Services--------------------------------------------------------- 295
Domestic Wildcatters Association, John E. Chapoton --------------------- 85
Dozier, M. Gardner, -Vice president and director, Vance, Sanders & Co., Inc- 339 Edison Electric Institute, W. Reid Thompson, chairman of the board and president of Potomac Electric Power Co------------------------------ 131
Eggers, Paul W., president, Geothermal Kinetics Inc --------- ----------- 195
Engineers' and Scientists' Joint Committee on Pensions, Dr. Robert M.
Sanders --------------------------------------------------------- 385
Evans, James H., vice chairman, Union Pacific Railroad, Association of American Railroads---------------------------------------------- 165
Federated Research Corp., Charles H. Morin ------------ ---------------- 367
Federation of American Hospitals, John A. Bradley, president -------------287
Filer, John H., chairman, Aetna Life & Casualty Co---------------------- 27
Fishwick, John P., president and chief executive officer, Norfolk & Western
RailwayCo., Association of American Railroads --------------------- 165
Florida East Coast Railway Co., W. L. Thornton, president ---------------171
Gehrig, Leo J., M.D., senior vice president, American Hospital Association- 375 Geothermal Kinetics, Inc., Paul W. Eggers, president ------------------ 195
Governors of the Kni ghts .of Ak-Sar-Ben, Kenneth H. Liles ---------------265
Halvorson, Newman T., Jr., Covington & Burling, for May Department
Stores Co -------------------------------------------------------231

Healy, Edward, president, National Association of Water Companies---- 127 Hoopes, Townsend, for Association of American Publishers and the Ad Hoe
Committee for Equitable Tax Treatment of the Publishing Industry---- 39 Hotel & Restaurant Employees & Bartenders International Union, AFLCIO, Robert E. Juliano, legislative representative -------------------- 65
Independ ent Petroleum Association of America, A. V. Jones, Jr., president- 115 International Association of Fairs & Expositions, Kenneth H. Liles ----- 265 Investors Syndicate of America, Inc., Kenneth R. Wahlberg, president ---- 55 Johns-on, Lane Space, Smith & Co., Inc -------------------------------- 359
Jones, A. V., Jr., president, Independent Petroleum Association of America- 115 Juliano, Robert E., legislative representative, Hotel & Restaurant Employees & Bartenders International Union, AFL-CIO ---------------------- 65
Kansas City Southern Railway Co., Thomas S. Carter, president --------- 183
Karp, Irwin, counsel, Authors League of America ---------------------- 51
Lineman, Kent M --------------------------------------------------- 399
Kreutzer, Arthur C., vice president and general counsel, National LP-Gas
Association ----------------------------------------------------- 219,413
Liles, Kenneth H., of Sutherland, Asbill & Brennan, for Association of Art
Museum Directors; International Association of Fairs & Expositions; Governors of the Knights of Ak-Sar-Ben; Los Angeles County Fair; Maryland State Fair; Pacific International Livestock Exposition; American Livestock Show and Rodeo Managers' Association -------------- 265,285
Los Angeles County Fair, Kenneth H. Liles ---------------------------- 265
Low, James P., president and chief executive officer, American Society of
Association Executives --------------------------------------------- 271
MacCallan, W. David, director, Association of Closed-End Investment Companies --------------------------------- --------------------------- 143
Maryland State Fair, Kenneth H. Liles -------------------------------- 265
May Department Stores Co., Newman T. Halvorson, Jr., Covington & Burlington ----------------------------------------------------------- 231
McIntyre, Hon. Thomas J., a U.S. Senator from the State of New Hampshire ------------------------------------------------------------- 11
Mighdoll, M. J., executive vice president, National Association of Recycling
Industries, Inc ------------------------------------------------------ 201'
Morin, Charles H., for Federated Research Corp ------------------------ 367
National Association of Recycling Industries, Inc., M. J. Mighdoll, executive vice president ------------------------------------------------- 201
National Association of Water Companies, Edward Healy, president ------ 127 National Consumer Center for Legal Services, Sandy Dement, executive director ------------------------------------------------------------- 295
National LP-Gas Association, Arthur C. Kreutzer, vice president and general counsel ------------------------------------------------------ 219,413
Newton, Blake T., Jr., president, American Council of Life Insurance ---- 149 Nolan, John S., Miller & Chevalier ------------------------------------ 251
Pacific International Livestock Exposition, Kenneth H. Liles ------------ 265
Rogers, Dr. N. Jay, partner, Texas State Optical Co --------------------- 59
Rosan, Richard A., for the American Gas Association ------------------- 137
Sanders, Dr. Robert Al., for Engineers' & Scientists' Joint Committee on
Pensions ---------------------------------------------------------- 385
Savage, Carroll J____ -------------------------------------------------- 159
Sebits, Carl W ------------------------------------------------------- 407
Snarr Advertising, Inc., Douglas T. Snarr, president -------------------- 41T
Society of Manufacturing Engineers, R. William Taylor, executive vice
president and general manager -------------------------------------- 281
Solar Energy Industries Association, Sheldon H. Butts, president -------- 13 Stackpole-Hall Foundation, Richard F. Barrett ------------------------ 243
Taylor, R. William, executive vice president and general manager, Society
of Manufacturing Engineers ---------------------------------------- 281
Texas State Optical Co., Dr. N. Jay Rogers, partner -------------------- 50
Thompson, Myron B., Honolulu, Hawaii ------------------------------- 391
Thompson, W. Reid, chairman of the board and president of Potomac Electric Power Co., for Edison Electric Institute ------------------------- 131
Thornton, W. L., president, Florida East Coast Railway Co ---- 7 -------- 171
Vance, Sanders & Co., Inc., M. Dozier Gardner, vice president and director- 339 Wahlberg, Kenneth R., president, Investers Syndicate of America, Inc --- 55

Additional administration views --------------------------------------- 427


ON SECTION 1308 OF H.R. 10612

I urge the adoption of Section 1308 of the Senate version of the Tax Reform Act which amends Section 543(a) of the Internal Revenue Code.

1. Under Section 543(a)(6) of the Internal Revenue Code rents received by a corporation from a 25 percent or more shareholder for the use of corporate property is treated as personal holding company income unless its other personal holding company income is 10 percent or less of its gross income.

2. The Internal Revenue Service has taken the position that payments received for the lease of intangible property to a shareholder are royalties under Section 543(a)(1) rather than

rents under Section 543 (a) (6) .

3. There should be no distinction between tangible

and intangible properties leased to a shareholder where they are part of an integral group of business assets used by the shareholder in an active trade or business.

4. This provision retroactively corrects the statute to allow similar treatment for tangible and intangible assets leased to a shareholder for use in his business. It does not, however, allow shareholder rents to be nsed to shelter other


passive income and preserves the intent of the personal holding company provisions.

S. Retroactive relief is even more justified for

this provision than when the Congress granted similar retroactive relief in 1950 and 1955.


ON SECTION 1308 OF H.R. 10612

Mr. Chairman,, I wish to thank the Committee for

giving me an opportunity of appearing before it in support of Section 1308 of the Committee bill.. This provision is the same as S. 3288 which Senator Sparkman and I introduced last April as an amendment to Section 543(a) of the Internal Revenue Code.

The purpose of this provision is to correct what I believe is an unintended result occasioned by the personal holding company provisions dealing with rental payments by shareholders to their corporations. Specifically, the problem involves the treatment of payments received for leasing intangible property as royalties under Section 543(a)(1) rather than shareholder rents under Section 543(a)(6).

The problemVas first presented to me through a company in my home state of Alabama whose stock is owned by two trusts. The Company owns and leases to several partnerships assets usedby each partnership in the business of making and selling a soft drink product within a specified area. The two trusts own a majority of the partnership interests of each partnership, and three individuals own the minority partnership interests. The assets used by these partnerships consist of land and buildings, machinery and equipment, automobiles, delivery equipment and coolers, and the exclusive right to make and sell


the Product within such specified area. The reason for this manner of operating the business is that in 1934 ownership of all of the assets, tangible and intangible, used in the business was transferred to the Company in order to conserve and preserve title to these assets in a continuing entity, thereby insulating these assets from the death of, or other changes in, the partners of the partnerships.

The Internal Revenue Service has taken the position that the Company was a personal holding company on the grounds that a substantial portion of the payments to the Company from the partnerships should be treated as royalties under section 543(a)(1) of the Code rather than as compensation for the use of corporate property under section 543(a)(6). The Internal Revenue Service takes the position that the payment for the exclusive right to make and sell the product is a royalty.

Section 543(a)(6) of the Code provides that amounts

received as compensation for the use of, or right to use, property of the corporation, where 25 percent or more of its stock is owned by an individual entitled to use the property, constitutes personal holding company income, unless its other personal holding company income (excluding rents under section 543(a)(2)) is 10 percent or less of its ordinary gross income. That is, payments for the use of corporate property by its


shareholders will not constitute personal holding company income unless these payments are used to shelter passive income in excess of 10 percent of the corporation's ordinary gross income. Since the portion of the payments from the partnerships which are treated by the Service as income (i.e., the royalties) under section 543(a)(1) was greater than 10 percent of the ordinary gross income, all of the payments from the partnerships constituted personal holding-company income under sections

543 (a) (1) and 543 (a) (6).

The Company had no other personal holding company

income other than a minor amount of interest income in several years amounting to far less than 10 percent of its ordinary gross income for any such year.

Thus, the Company has not been used to shelter passive investment income since practically all of its income comes from the payment for use of business properties--i.e., those in connection with the manufacture and sale of the product. Nevertheless, it has been unwittingly trapped into personal holding company status because, although all of the income which it receives from the partnerships is for the use of assets comprising a single business, some of this income is treated unfairly as income under section 543(a)(1) rather than as compensation for the use of corporate property under section 543(a)16).


The statute should be amended to provide that all of such payments should be treated as compensation for the use of corporate property under section 543(a)(6), so that such payments wili constitute personal holding company income only if these payments are used to shelter substantial amounts of other passive investment income. The legislative history of section 543(a)(6) clearly demonstrates that rents from stockholders for the use of property in legitimate business enterprises are not intended to be classified as personal holding company income unless these rents are used to shelter other passive investment income.

In the past Congress has provided retroactive relief under a similar set of circumstances. Prior to the Revenue Act of 1950, personal holding company income included amounts received for the use of corporate property by 25 percent shareholders. By 1950 the attention of the Finance Conunittee had been called to examples "where, through a set of fortuitous circumstances, corporations have become closely held and also have rented most of their assets for use in the operation of businesses to the individuals holding the stock of the companies. Thus, unwittingly the corporations have become personal holding companies and subject to the penalty tax." S. Rept. No. 2375, 81st Cong. 2nd-Sess. (1950), 65. To take care of this problem,


section 223 of the Revenue Act of 1950 provided for the elimination of rents for the use of a corporation's property by its shareholders from the category of personal holding company income, where the property is used "in the operation of a bona fide commercial, industrial, or mining enterprise." This provision applied retroactively to taxable years ending after 1945 and before 1950. In 1955, the application of this relief provision was extended again retroactively to years before 1954, in recognition of the fact that the Internal Revenue Code of 1954 provided relief from this problem for years beginning with 1954. See H. Rept. 1353, 84th Cong. lst Sess. (1955), 1955-2 C.B. 844.

The 1954 Code relieved this problem by exempting shareholder rents from personal holding company income unless the corporation has other personal holding company income in excess of 10 percent of its ordinary gross income. Thus, the basic purpose of section 543(a)(6) is to prevent payments from shareholders to corporations from sheltering outside passive investment income. See S. Rept. No. 1622, 83rd Cong. 2nd Sess. (1954), 74, where in connection with section 543(a)(6) the Finance Committee stated that "in the absence of appreciable amounts of other investment income, rental income received from shareholders does not constitute a tax avoidance problem."


The continued concern of Congress since 1950 for

exempting from personal holding company income payments for the use of corporate property by shareholders in their active business clearly should cover situations, like the instant case, where the assets of the corporation used in the shareholders' business consist of intangible, as well as tangible, property. Such a corporation is no more the "incorporated pocketbook" at which the personal holding company provisions are aimed than a corporation whose assets happen not to include intangible rights necessary for the business,,and such corporation should not be trapped into personal holding company status in the absence of the proscribed amount of outside investment income.

It is important to note that this amendment will apply only where the intangible assets are part of an integral group of business assets consisting of tangible and intangible assets, and will not apply where the corporation merely licenses an intangible asset. Also, the amendment leaves undisturbed and preserves the existing prohibition against using payments from shareholders for the use of business assets to shelter substantial amounts of outside investment income. The amendment also insures that rents and royalties which are described under section 543(a)(6) and are excluded from personal holding company


income under that section will be excluded from sections 543

(a) (1) and 54 3 (a) (2 ) .

Since the purpose of this amendment is to relieve the unintended hardship of section 543(a)(6) on a taxpayer who unwittingly became trapped into personal holding company status this amendment should be made retroactive in a manner similar to what we did in 1950 and 1955. Actually there is more justification for retroactive relief here than in the previous cases since here we are correcting a situation not intended by the statute while before we merely granted relief from a clear statutory provision.

The Treasury voiced no objection to this amendment in

its Administrative Position dealing with this bill dated June 15, 1976. However, apparently because of the recent publicity surrounding this and other amendments, the Treasury now attempts to criticize the amendment by claiming that the favorable treatment for rents should not apply to passive income such as royalties. But this claim is specious, since it is clear that the amendment covers only the limited situation of payments for intangible property which is leased along with tangible property for use in a single active business, in which case the payment for the intangible property should be treated the same as the payment for the tangible property. This situation does not


allow circumvention of the personal holding company provisions, as would exist in the case of the mere receipt of royalties by a corporation existing to hold title to intangible assets. The Treasury has confused this latter situation with the one covered by the amendment, since the lease of an integrated business consisting of tangible and intangible property does not constitute a technique for avoiding the personal holding company provisions.

This same confusion underlies the Treasury's claim that it is inappropriate to permit individuals to accumulate royalty income in their corporation. Where an integrated business consisting of intangible and tangible property is leased, the payment for the intangible property cannot be characterized as passive income, as in the case of mere royalty payments received by a corporation for the use of intangible property alone. The payments for the integrated business should, as in the case of rents under, be free from personal holding company taint.

While it is true that the amendment does not provide relief for payments from non-shareholders for intangible assets leased along with tangible assets in an integrated business, such relief is fully warranted and should be provided in future legislation.




Mr. Chairman, thank you for the opportunity to speak before the Committee on Finance today. I am here to urge that the Cajnittee give its full support, both on the Senate Floor and in conference with the House, to the solar energy tax credit provision as reported in the Senate version of H.R. 10612.

My statement at this time is very brief, but I wish to include for the Committee's information, as an appendix to my statement, the testimony of Sheldon Butt, President of the Solar Energy Industries Association, showing that the tax credit for solar energy can significantly reduce the Nation's dependence on foreign oil while providing jobs for American workers.

I shall forward more detailed remarks of my own to the Committee at a later date.

Thank you.










JULY 229 1576

Submitted by: Sheldon H. Butt President Solar Energy Industries Assn.

74-659 0 76 2


The Solar Energy Industries Association is pleased to be able to comment on H.R.10612, the Tax Reform Act, which provides for tax credits for the installation of solar energy equipment. We believe that the tax treatment proposed is amply justified and extremely important to accelerating the use of solar energy equipment and technology.

The technology required for solar heating applications is, indeed, available today. Solar space heating equipment and solar water heaters are available commercially from an increasingly large number of manufacturers. The number of installations is increasing. A survey made recently by the Federal Energy Administration indicates that installations of medium temperature solar collectors in 1975 were over four times those made in 1974. However, volume is still small as compared to the magnitude of the energy problem.

The applications involved, heating building space both in
residences and in nonresidential structures and heating domestic hot water, are important. Together, they account for over 20 percent of the entire national energy budget. Furthermore, the scarce fuels which we seek to conserve -- oil and gas -- accountfor a large part of-the energy used in these applications. Thus, the energy application area which will be impacted is one which is peculiarly important to the nation.

It is anticipated that, within no more than fifteen years, with
vigorous government programs designed to support accelerated utilization of the solar resource, solar energy can replace 1,000,000 barrels of crude oil per day. This will represent 15 to 20 percent of our continuing energy imports (primarily foreign oil) otherwise required, even after credit is taken for planned accelerated development of other "new" and existing convention energy resources and for the probable effect of accelerated conservation efforts.

The tax credit proposed for solar energy equipment amounts to
40 percent of the first $1,000 of expenditures, plus 25 percent of the next $6,400 for a maximum credit of $2,000. SEIA is in favor of this 11step" proposal for two reasons. In the first place, it will provide the largest incentive to the owner of the relatively small home who needs a relatively smaller and less expensive installation. The owner of the smaller home is characteristically in a lower income bracket than the owner of the large home and needs additional help.


Secondly, a 40 percent credit on the first $2,000 will particularly provide an incentive to the installation of solar water heaters. These are the most productive in terms of energy savings, the most ready to move into the marketplace in large quantity, and they will lead to general acceptance of solar energy for heating and cooling.

Attached to these comments is a detailed projection of solar water heater, space heating and cooling sales in new construction and for retrofit of existing installations.

An important concept to understand with regard to an individual who installs solar equipment is that he becomes a producer of energy. In fact he becomes an energy producer just as much as is the electric utility company which purchases and installs new generating capacity, the coal mining company which purchases and installs mining equipment, or the oil and gas producer who drills an oil or gas well or builds a refinery or pipeline. All of these industries receive specialized tax treatment, in common with other industries. Indeed, the only exception is the homeowner who becomes an energy producer but who receives no specialized tax treatment under existing legislation.

Simply stated, we are asking for equitable treatment for the .homeowner-energy producer.

We do not dispute the need for the tax benefits presently received
by the conventional energy industries. They, as well as other industries, deserve and need the investment tax credits and depreciation allowances now received, as well as, in many cases, the depletion allowances granted them as a means of assisting them to attract and generate the capital funds required to support and expand their production. We are asking that equivalent treatment not be denied to producers of solar energy.

We believe that it is important that we look at the government
investment required and compare it with the government investment required through the existing tax laws -- by the electric alternative.

If we look at the solar installation by itself (without the use of off-peak electric energy married to it), we find that government investment in tax credits would be $60 to $70 per barrel of oil saved per year. This would total $22-$25 billion spread over ten or fifteen years to save a million barrels of oil per day. At today's prices for imported crude oil, the foreign exchange savings would repay the government investment in five or six years.

We may compare the $60 or $70 investment per barrel saved through solar alone with the government investment required to replace the same barrel of crude oil with new electric generating capacity. Based upon the present investment tax credits and depreciation allowances now received and their effect upon taxes paid, the electric alternative would require a much larger government investment. It would cost $150 per barrel saved or over twice as much as solar alone. The total government investment involved in saving a million barrels of oil per day with electric energy


is $55 billion. However, if we marry solar energy for 60 percent of the structure's thermal energy requirements with off-peak electricity for the remaining 40 percent, the taxpayers need only invest $40 per barrel of oil saved or only $15 billion over the ten or fifteen year period to save a million barrels per day. The $40 per barrel investment would be repaid by foreign exchange savings in less than three years,

One of the effects of the government's investment in solar
facilities or in other energy producing facilities is to stimulate investment and spendingin the private sector. The government's investment increases economic activity and increased economic activity increases tax revenues which offset the government investment. This is particularly true in the case of the government investment in solar heating facilities. As we indicated previously, solar equipment and solar installations are relatively labor intensive and therefore are particularly effective in stimulating economic activity. Stimulation is rapid since the lead time for new solar energy producing facilities is very short as compared to the long lead times involved in the building of new electric generating facilities.

In conclusion we have seen that solar water heating, space heating and cooling can provide a substantial input to the nation's energy budget in the next ten to fifteen years. We have seen that it can do this cost-effectively using existing technology. We expect that this technology will continue to be used in the more distant future and that, p1timately, it can provide from 10 percent to 15 percent of our total energy budget.

In that light, it appears that it is in the national interest to undertake aggressive government action which will stimulate the growth of the infant solar industry and benefit from the reduction in oil imports that will be achieved. We believe that the solar energy tax credit presently provided for in H.R.10612 will be a mostAmportant step in that direction.



One of the important characteristics of solar systems is that, once purchased, they "fix" the cost of the energy they produce at a level equal to the carrying cost of the capital investment required. Thus, they represent a form of "inflation insurance." Therefore., it is important to note that these projections are based upon the expectation that general inflation will average 5% per year and further, that escalation in electric energy prices will be 2-1/2% per year higher than the general rate of inflation and that escalation in heating oil and natural gas prices will be 5% per year greater than the general inflation rate.
Most economists anticipate that inflation will average 5% to 6%
per year. Inflation in this range appears to be "institutionalized" within our economic structure. There is little, if any, honest expectation that inflation rates will be lower. There is significant danger that t hey might be higher in the event of future worldwide food crises or in the event that the O.P.E.C. nations elect to become less restrained and more predatory in their crude oil pricing policies.

The 2-1/2% higher escalation rate projected for electric energy costs is based upon the expectation that primary fuel costs, after allowing for inflation, will continue to increase and upon the reality that new generating capacity costs a great deal more than existing capacity. As new capacity is added to the mix, the average cost of all existing capacity included in the utility rate base increases and rates correspondingly increase.

Projected escalation in fuel oil prices is based on the expectation that, first of all, the O.P.E.C. nations will raise prices to keep up with worldwide inflation (which is higher elsewhere than in the United States) and that the prices of domestically produced crude oil will continue to increase, eventually reaching the "world price" level. This will increase the average price paid by U. S. refineries for crude oil.

Solar water heaters will become a major market factor most rapidly. There are several reasons. Hot water requirements are year-round and thus, the user's investment in a solar hot water heater achieves maximum utilization. Solar water heater installations are small as compared to space heat-


ing installations. 'The task of finding a suitable place to install the collector in a retrofit water heater installation is relatively simple. Furthermore, a normal solar hot water heater installation consists of the collector system and its associated controls and other hardware, and a solar hot water storage tank placed in series with a conventional hot water heater. To make a retrofit installation, it is only necessary to make a modest change in the plumbing so that the solar hot water storage tank is placed in the line ahead of the existing conventional water heater. A solar hot water heater, which can be conveniently added to existing structures as a retrofit installation, commands a large market potential. During the earlier years of solar market development, while the total number of solar installations is still modest and long term operating experience is lacking, the fact that the user's investment in a solar water heater is small as compared to a solar space heating investment, will lead many users to limit their risk by investing only in a water heater.

The table which follows details our projection of residential solar water heater sales in new construction and for retrofit:


Solar Solar
Water Market Water
Market Heaters, Penetration, Heaters, TOTAL,
Penetration, Thousand Percent Thousandtl) Thousands
Year Percent Of Unitsb) Year CumulativF Of Uni.ts Of Units

1 0.5% 9 0.03% 0.03% 21 30
2 2.0 36 .10 .13 72 98
3 3.5 64 .25 .38 183 247
4 5.5 102 .60 .98 444 546
5 8.0 152 1.00 1.98 750 902
6 11.0 211 1.32 3.3 1,003 1,214
7 15.0 291 1.70 5.0 1,309 1,600
8 20.0 392 2.0 7.0 1,560 1,952
9, 25.0 495 2.3 9.3 1,817 2,312
10 30.0 600 2.7 12.0 2,160 2,760
11 36.0 727 3.1 15.1 2,511 3,238
12 44.0 898 3.4 18.5 2,788 3,686
13 52.0 1,071 3.65 22.15 3,030 4,101
14 59.0 1,227 3.85 26.0 3,234 4,461
15 65.0 1,365 4.00 30.0 3,400 4,765

(1) 1 unit equals the water heater for one dwelling unit. An installation
to provide hot water for 10 units in a multiple family apartment is
counted as 10 units.

As in the case of subsequent tables, "Year V is the first full year after the Government programs which have been called for by S.E.I.A. have been enacted and implemented. If this is accomplished in 1976, "Year 1" is 1977.


The next table converts unit sales of residential solar water heaters into dollar sales, expressed in 1976 dollars (without further inflation), and also shows the barrels of crude oil or its equivalent which will be saved through their use. Since fuel savings depend upon the cumulative number of units installed, the cumulative total installed is given:


Dollar Value
(1976 Dollars)
Solar Water Of Units Barrels of Crude Oil
Heaters Installed, Installed (Or Equivalent)
Thousands of Units In The Year FeT Year Saved
Year Year cumuMat-ive Millions Per Fay5 902 1,833 $ 795 6,844,000 18,750
10 2,760 11,671 2,165 44,530,000 122,000
15 4,765 31,922 3,500 121,180,000 332,000


Although residential applications are the major potential markets for solar water heaters, substantial market potential exists in nonresidential applications, including:

Office Buildings
Car Washes
Other businesses using hot water

Initial significant penetration of this market is expected to be somewhat slower than in the case of residential water heaters. One reason is the very diverse nature of the market and the fact that many of the individual applications are highly specialized. In the long run, market penetration is expected to be substantial since in the present regulatory climate, many areas of energy consumption by "business" are more subject to curtailment and reduced allocation of scarce fuels during periods of shortage than are residential users. For example, regulatory bodies may well consider that energy required for heating domestic hot water for use in office buildings or energy required for heating hot water used in car washes is relatively nonessential. Our market projection for solar water heating for nonresidential applications follows:


Square Feet
Energy Of "Standard"
Consumption Market Solar Collectors
Penetration, % Installed,
Year 1015 Btu/Year Year Cumulative Thousands

1 .61 .0005% .0005% 7.6
2 .63 .001 .0015 16.0
3 .65 .003 .0045 48.8
4 .67 .01 .0145 167.5
5 .69 .03 .0445 517.5
6 .71 .08 .12 1,420
7 .73 .16 .28 2,920
8 .75 ..32 .59 6,000
9 .77 .6 1.18 11,550
10 .80 1.0 2.13 20,000
11 .82 1.4 3.48 28,700
12 .84 1.7 5.10 35,700
13 .87 2.0 6.92 43,500
14 .90 2.3 9.00 51,750
15 .92 2.5 11.3 57,500

In turn, we have converted unit sales (expressed as the square* feet of "standard" solar collectors used in the system) into dollar sales for complete systems, and we have also tabulated the crude oil-or its equivalent replaced by solar energy. This tabulation follows:


Square Feet Dollar Value
Of "Standard" (1976 Dollars)
Solar Collectors Of Units Barrels of Crude Oil
Installed, Installed (Or Equivalent)
Thousands In The Year Saved
Year Year Cumulative Millions Per Year Per Day

5 517.5 757.4 $ 8 58,400 160
10 20,000 42,600 250 3,285,000 9,000
15 57,500 259,800 635 20,075,000 55,000



In most cases, solar space heating will be combined with solar domestic hot water heating--there will be few solar systems which are intended for heating only and do not also generate hot water. To simplify presentation of our projections, the dollar figures and crude oil saving figures presented represent only the additional sales value attributable to solar space heating itself and the additional crude oil savings resulting from solar space heating. The information p resented is additive to the solar water heater projections. For example, we project 30,000 residential solar space heating installations in the fifth year in new construction and 152,000 solar water heaters in new residential construction. This means that there will be 30,000 installations made which perform the functions of both space heating and water heating and 122,000 which are water heaters only. Our projections follow:

NEWCONSTRUCTION ________________Solar Solar
Space Market Space
Market Heaters, Penetration, Heaters, TOTAL
Penetration, Thousand Percent Thousandi ) Thousands
Year Percent Of Uni tsb ) Year Cumulative' Of Units l) Of Units

1 0.1% 2 0.0006% 0.0006% .4 2.4
2 .2 4 .0012 .002 .9 4.9
3 .4 7 .0024 .004 1.8 8.8
4 .8 15 .005 .009 3.7 18.7
5 1.6 30 .01 .019 7.5 37.5
6 3.2 61 .02 .039 15.2 76.2
7 6.0 116 .04 .078 30.8 147.4
8 11.0 216 .09 .17 70.2 286.2
9 18.0 356 .2 .37 158 514
10 24.0 480 .4 .76 320 800
11 30.0 606 .7 1.45 567 1,113
12 35.0 714 1.2 2.63 984 1,698
13 3E.0 783 2.0 4.60 1,660 2,443
14 40.0 832 2.8 7.35 2,35? 3,184
15 42.0 882 3.5 10.76 2,975 3,857

(1) 1 unit equals the water heater for one dwelling unit. An installation
to provide hot water for 10 units in a multiple family apartment is
counted as 10 units.

The following table converts unit sales into dollar sales and into
barrels of crude oil or its equivalent saved:


Dollar Value
(1976 Dollars)
Solar Space Heaters Of Units Barrels of Crude Oil
Installed Installed (Or Equivalent)
Thousands of Units In The Year Saved
Year Year Cumulative Millions Te-F Year Per NY

5 7.5 14.3 120 912,500 2,500
10 320 608.5 2,300 25,550,000 70,000
15 2,975 9,147 10,800 173,375,000 475,000


In the longer term, good penetration of this market is expected and again, particularly because of the greater vulnerability of many segments of this market to curtailment and allocation of conventional energy resources. Our projection for nonresidential space heating follows:

Square Feet
Energy Market Of "Standard"
Consumption Penetration, Solar Collectors
Percent Installed,
Year 1015 Btu/Year Year Cumulative Thousands

1 4.28 .0002%' .0002% 29
2 4.37 .0004 .0006 60
3 4.45 .0008 .0014 123
4 4.54 .002 .0034 311
5 4.63 .005 .0083 793
6 4.73 .015 .023 2,430
7 4.82 .035 .058 5,778
8 4.92 .07 .13 11,796
9 5.01 .12 .24 20,591
10 5.11 .20 .44 35,004
11 5.22 .35 .78 62,575
12 5.32 .6 1.37 109,326
13 5.43 .9 2.24 167,380
14 5.54 1.3 3.49 246,669
15 5.65 1.7 5.13 328,971

The following table converts square footage of "standard" collector into dollar volume of the complete solar systems in 1976 dollars (excluding inflation) and to barrels of crude oil or equivalent saved per day:



Dollar Volume
Solar Space Heating (1976 Dollars)
Installed, Thousands Of Units Barrels of Crude Oil
Of Square Feet Of Installed (Or Equivalent)
Standard Collectors In The Year Saved
Year Year Cumulative Millions Per Year Per Da

5 800 1,300 16 73,000 200
10 35,000 77,000 600 4,380,000 12,000
15 330,000 992,000 5,000 54,750,000 150,000


Air-conditioning, for both residential and nonresidential application, will be the slowest developing solar application. Although technically suitable solar air-conditioning equipment is now available, it is costeffective only in a very limited range of applications. Additional engineering development is required. to reduce cost and increase efficiency so as to broaden potential market base. Of course, the rising cost of conventional energy sources will also contribute to eventually making solar air-conditioning broadly cost-effective.

Residential air-conditioning applications will grow more slowly than nonresidential. This presents a contrast to the water heating and space heating market in which residential applications are expected to grow the most rapidly. The "cooling season" for commercial buildings, such as stores and office buildings, is longer than the residential cooling season. Thus, in these important markets, the solar equipment will be better utilized than in residential applications. In the southern part of the country, air-conditioning of stores and office buildings is very nearly a year-round load. The majority of nonresidential air-conditioning systems are chilled water systems in which the "product" of the air-conditioning machinery is chilled water. These systems lend themselves to retrofit with a solar unit in which the collectors and solar heat driven chiller supplement the existing conventional equipment. In some cases, only the solar collection system must be added since a substantial number of heat actuated chillers are now in use. Finally, the typical solar driven, heat actuated chiller requires the use of a cooling tower. Cooling towers are now widely used for heat rejection in commercial airconditioning installations but are not generally used in residential installations. The operating complexity imposed by the cooling tower is not a material deterrent to the use of solar air-conditioning in nonresidential applications. It is a meaningful deterrent in the case of the residential applications, particularly so in single-family residences.

Our projection for residential solar air-conditioning installations follciis. As in the case of residential space heating and residential water hea-ling, the figures are additive to those for space heating and water heatin-. For example, in the tenth year in which we project 30,000 residential solar air-conditioning installations, 800,000 solar space heaters and .


2,760,000 residential solar water heaters, this means 30,000 residential systems with solar air-conditioning, space heating and water heating; 770,000 with space heating and water heating and 1,960,000 water heaters alone. Our projections follow:


Air-Conditioner Market
Installed Penetration,
Year Thousands(l) Percent

1 .01 .0006%
2 .02 .0011
3 .04 .0022
4 .08 .0043
5 .20 .011
6 .77 .04
7 2.9 .15
8 7.8 .4
9 15.8 .8
10 30.0 1.5
11 50.5 2.5
12 81.6 4.0
13 124. 6.0
14 166. 8.0
15 210. 10.0

(1) -1 unit equals the water heater for one dwelling unit. An installation
to provide hot water for 10 units in a multiple family apartment is
counted as 10 units.

The next table converts installed units to dollar sales in constant 1976 dollars (without inflation) and savings in barrels of crude oil or its equivalent per year and per day:


Dollar Volume
Solar (1976 Dollars)
Air-Conditioners Of Units Barrels of Crude Oil
Installed, Installed (Or Equivalent)
Thousands InThe Year Saved
Year Year Cumulative Millions Per Year Per Day

5 .2 .35 .9 767 2.1
10 300 57.6 60. 94,900 260
15 210 690. 675 1,423,500 3,900

As discussed previously, nonresidential solar air-conditioning will grow much more rapidly than residential. In this one particular case, the totals are generally not additive to the totals for space heating and water heating. Our projection follows:



Square Feet
Energy Of "Standard"
Consumption Market Solar Collectors
15 Penetration, % Installed,
Year 10 Btu/Year Year Cumulative Thousands

1 1.63 .00003% .00003% 5
2 1.68 .00006 .00009 10
3 1 73 .00011 .00019 20
4 1.78 .00021 .00040 40
5 1.8 .0005 .00089 100
6 1.89 .0015 .0024 300
7 2.02 .005 .0072 1,060
8 2.08 .012 .019 2,600
9 2.15 .03 .048 6,800
10 2.21 .06 .11 14,000
11 2.28 .11 .21 26,000
12 2.34 .20 .41 49,000
13 2.41 .35 .75 88,500
14 2.49 .6 1.32 157,000
15 2.56 .9 2.19 240,000

The following table converts these projections into dollar volume
in 1976 dollars (without inflation) and to barrels of crude oil or its equivalent saved per year and per day:


Square Feet Dollar Value
Of "Standard" (1976 Dollars)
Solar Collectors Of Units Barrels of Crude Oil
Installed, Installed (Or Equivalent)
Thousands In The Year Saved
Year Year Cumulaf'-ve Millions Per Year PerPay

5 100 175 2.1 3,650 10
10 14,000 25,000 260 438,000 1,200
15 240,000 585,000 3,900 10,950,000 30,000


Our next table summarizes dollar volume of solar units in all
heating and cooling applications:



5 Yrs. 10 Yrs. 15 Yrs.

Water Heaters
New Residential 120 435 950
Retrofit Residential 675 1,730 2,550
Nonresidential 8 250 635

Space Heating
New Residential 90 1,200 1,900
Retrofit Residential 30 1,100 8,900
Nonresidential 16 600 5,000

Residential .9 60 675
Nonresidential 2.1 260 3,900

TOTAL 942 5,635 24,510

Similarly, the final table summarizes crude oil savings in barrels per day:


5 Yrs. 10 Yrs. 15 Yrs.

Water Heaters
New Residential 3,750 25,000 80,000
Retrofit Residential 15,000 97,000 252,000
Nonresidential 160 9,000 55,000

Space Heating
New Residential 2,000 50,000 175,000
Retrofit Residential 500 20,000 300,000
Nonresidential 200 12,000 150,000

Ai r-Condi tioni ng
Residential 15 2,500 30,000
Nonresidential 10 1,200 30,000

TOTAL 21,635 216,700 1,072,000

It should be noted that these projections are predicated upon the development and implementation of a comprehensive and aggressive Government program designed to stimulate the growth rate of solar applications. Without the Government programs which the Solar Energy Industries Association has recommended, growth rate would be slower, although ultimately the same level of market penetration, sales and crude oil savings would be reached.


Summary of Statement of
John H. Filer
Before the Senate Finance Committee July 22, 1976

1. Section 1508 of H.R. 10612 allows the filing of consolidated returns by both life insurance companies and mutual property-casualty insurance companies with their noh-life affiliates, and thus eliminates existing discrimination against such companies by according them the same consolidation privilege that has long been industrial companies with non-life affiliates.

2. Through consolidation, section 1508 will permit
immediate, rather than delayed, use of the tax benefits derived from losses that would otherwise shrink the insurance writing capital base of casualty affiliates. In that way, the provision will help to preserve the capacity of such companies to write insurance at precisely the time when the public interest most urgently requires the maintenance and increase in that capacity. It also will eliminate pressures which distort the investment policies of casualty affiliates to the detriment of capital markets.

3. The amendment has been fully and openly presented to both tax-writing committees of Congress. It was the subject of a hearing by this Committee in April of this year, when all interested parties had a full opportunity to present their views. -It has also received favorable comment from the Joint Committee Staff, the Treasury Department and the Administration.

4. Section 1508 corrects a tax inequity, and helps alleviate a serious social and economic problem. In its presently modified form, it is a sound provision which should be retained in the bill.


Statement of John H. Filer
Before the Senate Finance Committee July 22, 1976

Mr. Chairman and Members of the Committee:

My name is John H. Filer. I am Chairman of the Aetna Life & Casualty Co. of Hartford, Connecticut.

I am appearing today, as I had the privilege of

appearing at your hearing on April 5, 1976, on behalf of an ad hoc group of twelve*/stock and mutual life insurance companies to urge your support of what is now section 1508 of H. R. 10612. Section 1508 eliminates existing discrimination in the Internal Revenue Code, by allowing both life insurance companies and mutual property-casualty insurance companies to file consolidated returns with their non-life affiliates, a privilege that has long been accorded industrial companies with such affiliates.

As I explained in my prior testimony, the recent severe losses incurred by the property-casualty insurance industry have dramatically accelerated the erosion of its surplus position. Since surplus is the ultimate measure of capacity to insure risks, the result has been to place severe limits on both new risk assumption and the renewal of existing coverage by casualty insurance companies. Consolidation as contemplated by section 1508 would permit the tax savings

*/ The twelve companies are: Aetna Life & Casualty, Hartford; CNA Financial Corp., Chicago; Connecticut General Life Insurance Company, Hartford; Equitable Life Assurance Society of the U.S., New York; Fidelity Mutual Life Insurance Company, Philadelphia; IDS Life Insurance Company, Minneapolis; Metropolitan Life Insurance Company, New York; Penn Mutual Life Insurance Company, Philadelphia; Prudential Insurance Company of America, Newark; Reserve Life Insurance Company, Dallas; State Mutual Life Assurance Company of America, Worcester; and Travelers Insurance Company, Hartford,


attributable to the losses of a casualty affiliate to be recognized and assigned immediately to the affiliate, thereby easing its surplus crisis on a current, rather than a delayed, basis. By permitting immediate recognition of losses, consolidation would also eliminate present pressures to distort the investment policies of casualty affili;Ates in a way that would be detrimental to the capital market for corporate equities and state and municipal bonds. In short, consolidation will have its most significant effect when losses threaten further shrinkage of the capital base of the casualty industry, and that is precisely the time when the public most urgently needs insurance capacity to be maintained and increased.

In its present form, section 1508 contains several modifications of the original proposal with respect to which I previously testified. These include a 50 percent limit on losses of affiliates that may be offset against life insurance company taxable income in any one year, a delayed effective date of January 1, 1978, and an elective provision. These modifications reflect a careful balancing.of various interests affected by the provision, without detracting from its overall objectives. Accordingly, I am pleased to indicate our continued strong support for section 1508 today.

In addition, through this statement I would like to

furnish the Committee with a complete chronology of the genesis of section 1508, so as to dispel any doubts regarding the full

74-659 0 76 3


and complete consideration it has received by the Congressional tax-writing committees.

On April 27, 1973, over three years ago, a

statement on the subject from counsel for our ad hoc

group was filed with the House Ways and Means Committee and printed in its Hearings on Tax Reform.

-- On July 25, 1973, the statement together with

lengthy, additional detailed memoranda were submitted

to the Staffs of the Joint Committee on Internal

Revenue Taxation and the Treasury Department for their

review and analysis.

-- House and Senate bills on this subject have

been before the Congress since January, 1975.

-- On September 15, 1975, Tax Analysts and

Advocates analyzed the proposal in its publication,

Tax Notes.

-- In February 1976, the proponents of the amendment requested permission to testify orally at the

Senate Finance Committee hearings on tax reform.

-- In April 1976, 1 appeared before the Committee

in support of the provision, and two groups opposed to

the provision filed written testimony with the Committee.

-- On May 25, 1976, the Treasury Department submitted a written report to Chairman Long, stating that


it was not opposed to the -concept of consolidation

embodied in the original proposal.

On May 27, 1976, the Finance Committee discussed and debated the proposal as it was presented

by Senator Ribicoff in open session. Favorable comment

was secured from the Joint Committee Staff. The

Treasury Department also restated its views at that session. The Committee then approved the amendment,

with the modifications I mentioned earlier, on a roll

call vote.

On June 15, 1976, after the Committee reported

the bill, the Administration stated that it had "no

objection" to section 1508.

It is apparent, therefore, that the amendment has

been fully and openly presented to the tax-writing.committees of Congress. It was in fact the subject of a hearing by this Committee in April of this year, when all interested parties had a full opportunity to present their views before the Committee reached its decision to adopt the proposal in its present form and include it in the pending bill.

For these reasons, we believe it is clear that section 1508 has received full and careful consideration by the Committee. The provision corrects a tax inequity, and helps alleviate a serious social and economic problem. we urge its retention in the bill.


Foley, Lardner, Hollabaugh & Jacobs 815 Connecticut Avenue, N. W. Washington, D. C. 20006 (202/223-4771) John W. Byrnes
July 22, 1976

Summary of Testimony
In Support of Section 21 01 -- Modification of
Transition Rule for Sale of Property By Private Foundations
On Behalf of'Badge'r Meter, Inc.,
Milwaukee, Wisconsin

1. Section 2101 of H.R. 10612 does not involve again or
,loss in revenue. It relates only to certain regulatory matters affecting private foundations.

2. The Tax Reform Act of 1969 in effect prohibited certain transactions between a private foundation and its
"disqualified persons" (generally, persons with an
economic or managerial interest in the operation of
the foundation). Among the transactions prohibited by the Act are the sale, exchange or leasing of property
by the foundation to such persons (section 4941).

3. In recognition of the hardship that would result if
certain existing leases of property by a private foundation to a "disqualified person" were immediately terminated, the Congress provided a transition rule permitting
a continuation, under certain circumstances, of such
leases until taxable years beginning after December 31, 1979. Prior to that date the leases must be terminated.

4. In some cases, such as the property currently leased by
the Charles Wright Foundation to Badger Meter, Inc., a disqualified person, the property was designed to meet
the particular needs of the lease and the continued use
of the property by Badger Meter, Inc., represents the
highest and most economical use of the property. To sell
or leasethe property to a third person would only be
possible at a financial sacrifice, while at the same time
Badger Meter, Inc. will not be able to acquire similar
property to meet its needs or will be able to do so only
at very substantial additional cost.

5. As the law presently stands, after December 31, 1979,
Badger Meter, Inc. can no longer continue to rent the
property from the Charles Wright Foundation, nor can it
purchase the property from the Foundation.

n A

6. If undue hardship to a foundation and its "disqualified person" is to be avoided under these circumstances, a transition rule is needed to permit a sale of
the property to the disqualified person in those
cases where the lease qualifies under the existing
transition rule relating to leases and the foundation
receives an amount which equals or exceeds the fair
market value of the property.

7. It is believed that the failure to provide such a
transition rule in the Tax Reform Act of 1969 was an
oversight. As stated in the Committee Report, "It appears likelythat if this particular point had been
presented in 1969, the Act would have been modified to
deal with the situation".

8. Section 2101 of H.R. 10612, Tax Reform Act of 1976, as
reported by the Committee on Finance, provides such a transition rule for those cases where the sale occurs
before January 1, 1978.


Foley, Lardner, Hollabaugh & Jacobs
815 Connecticut Avenue, N. W.
Washington, D. C. 20006 (202/223-4771) John W. Byrnes
July 22, 1976

Statement Submitted on Behalf of Badger Meter, Inc.
In Support Of
Modification of Transition Rule For
Sale of Property by Private Foundations

Section 2101 of H.R. 10612, Tax Reform Act of 1976


Badger Meter, Inc. of Milwaukee, Wisconsin, is a
substantial contributor to the Charles W. Wright Foundation, a private foundation, and comes within the definition of a "disqualified person" under the terms of the Tax Reform Act of 1969.

The manufacturing plant and administrative office of Badger Meter, Inc. is located in the Village of Brown Deer, Wisconsin. The administrative office was constructed to meet the needs of Badger Meter by the Charles Wright Foundation in 1957 on land acquired from Badger Meter. This land is contiguous to so me 51 acres of Badger Meter property on which there is 187,000 square feet of buildings. A part of the administrative building is on land owned by Badger Meter.

In 1957, a 20-year lease was entered into whereby
the Foundation leased the administrative building and surrounding land to Badger Meter. Subsequently, Badger Meter, at its own expense, made substantial improvements to the
buildings and land.Because of the close integration of the administrative building and other lease-hold improvements with the manufacturing plant and other facilities of Badger Meter, the continued use of the property by Badger Meter represents the highest and most economically feasible use of the property from the standpoint of both Badger Meter and the Foundation. Subsequent to the enactment of the Tax Reform Act of 1969, the property was appraised as required by the Act. The appraisers concluded that the highest and best use of the property is its present use, tha t the location of the office layout is not suited to multi-tenant occupancy and that in all likelihood, another single tenant would not be found because of the geographic location, existing and planned freeways and public transportation. They also concluded that the sale of the property to a third party would be extremely disadvantageous to the Foundation for the same reason.


Tax Reform Act of 1969

The Tax Reform Act of 1969 made substantial
changes in the law with respect to private foundations. Included in the changes was the imposition of taxes and penalties that in effect prohibit certain transactions between a private foundation and its "disqualified persons" (generally, persons with an economic or managerial interest in the operation of the foundation). Among the transactions covered by the prohibitions on such "selfdealing" is the sale or leasing of property.

Recognizing that the application of the new
rules to existing arrangements would, in certain circumstances, cause unnecessary disruption, the Congress provided transition rules to cover certain arrangements which had come to the attention of the Congress.

To cover the case where there was an existing
lease between the foundation and a disqualified person, the law permits a continuation of those leases in effect on October 9, 1969 until taxable years beginning after December 31, 1979, as long as the lease remains at least as favorable to the private foundation as it would have been between unrelated parties. However, after December 31, 1979, the leasing arrangement must be terminated.

Another transition rule permits a private foundation to sell to disqualified persons any business holdings that the private foundation was required to dispose of because of the business holdings provisions of the Act.

Overlooked in providing transition rules were situations where it would be advantageous for a foundation which has a lease with a disqualified person to sell the property to such person. Under the law as it presently stands, the foundation can neither continue to lease the property to the disqualified person after December 31, 1979, nor can the foundation sell the property to the disqualified person. The foundation must either find a new tenant or sell the property to a third person. In some situations, the leased property was designed or so modified to accommodate the disqualified person's business that it would be of little value to the foundation or anyone else, while the disqualified person will incur substantial additional cost if it has to acquire other property (which might not be available at any cost locally). Unless the transition rules are modified to make allowance for these cases, both the foundation and the disqualified person will suffer unnecessary losses.


Solution Section 2101

Section 2101 of H.R. 10612, Tax Reform Act of
1976 as reported by the Committee on Finance, makes a perfecting amendment to the transition rules to permit, for a limited period, a private foundation to sell to a disqualified person property previously leased to such disqualified person and which lease is within the present transition rule relating to leases to disqualified persons. It provides that such foundation shall receive for the disposition an amount which equals or exceeds the fair market value of the property.

The provisions of Section 2101 were unanimously
reported to the House of Representatives by the Ways and Means Committee in the 92nd Congress (H.R. 9520, Report 92-965), but
because of procedural problems, it was not considered by the House. In the 93rd Congress, the Ways and Means Committee approved the inclusion of the bill in the so-called Tax Reform Bill of 1974. The Committee, however, did not conclude its work on the bill and it was not reported to the House.

The Treasury Department filed reports on the bill in the 92nd and 93rd Congress raising no objections to the bill.

Similar bills have been introduced in the 94th Congress. (H.R. 11118 and H.R. 12564 by Congressmen Schnnebeli
and Karth, respectively.)

Because the time during which a private foundation
can continue to lease to a disqualified person is running out, it is imperative that Congress act at an early date to avoid severe and unintended penalties being imposed on certain foundations and their leases who find themselves in situations similar to that of Badger Meter, Inc. and the Charles Wright Foundation. Section 2101,as reported by the Committee on Financeprovides such a transition rule.


July 22, 1976

Statement of
The Association of American Publishers
The Ad Hoc Committee for Equitable
Tax Treatment of the Publishing Industry Submitted to
The Committee on Finance
United States Senate

Summary of Principal Points

1. The publishing industry of the United States strongly supports Section 1305 of H.R. 10612.

2. Section 1305 prevents retroactive application of Revenue Ruling 73-395 which purports to require publishers to capitalize prepublication expenditures directly attributable to development of textbooks and teaching..aids.

3. A-comprehensive survey establishes that such
capitalization''would be contrary to a long-standing and substantially uniform practice of deduction previously accepted by the Internal Revenue Service.

4. Deduction of these amounts is directly comparable to the deduction of research and development- expenses allowed to other industries.

S. The impact of Revenue Ruling 73-395 would fall
most heavily on educational-publications, which should not be subjected to additional burdens.

6. Section 1305 does no more than preserve the
status quo unless and until the-Treasury Department adopts new rules through the Regulation process, which affords interested parties an opportunity to be heard.

7. No revenue loss is involved since prior law is preserved.

8. For the foregoing reasons, Section 1305 which
was approved by the Committee on Ways and Means and passed by the House of Representatives, should be adopted by this Ccmmittee and the Senate.


Statement of
The Association of American Publishers and
The Ad Hoc Committee for Equitable
Tax Treatment of the Publishing Industry Submitted to
The Committee on Finance
United States Senate

July 22, 1976

I. Introduction

The Association of American Publishers, a not-forprofit trade association, represents publishers of 80 to 85 percent of the general books, textbooks and educational materials produced in the United States. The Ad Hoc Committee for Equitable Tax Treatment of the Publishing Industry represents Harcourt, Brace, Jovanovich, Inc.; Macmillan, Inc.; W.W. Norton, Inc.; and G. P. Putnam's Sons as well as all members of the Association of American Publishers. The Ad Hoc Committee thus represents publishers of approximately 90 percent of the books published in the United States.

The Association of American Publishers and the Ad Hoc Committee file this statement in support of.Section 1305 of H.R. 10612, which in substantially its present form was contained in the bill as passed by the House of Representatives and was approved by the Finance Committee during its open mark-up session on May 27, 1976.

Section 1305 will prevent the unfair retroactive

application of Revenue Ruling 73-395 by permitting publishers


to continue their customary treatment of prepublication expenditures without regard to that ruling until Treasury decides that these consistent practices should be changed. Any change would be-through prospective regulations issued with notice of proposed rule-making, thus providing the public an opportunity to comment formally.

The prepublication expenditures affected by Section 1305 are those paid or incurred in connection with the taxpayer's trade or business of publishing or writing for the writing, editing, compiling, illustrating, designing or other development or improvement of a book, teaching aid or similar product. These prepublication expenditures are the equivalent for the publishing industry of the research and development expenses of other industries which Section 174 of the Code allows to be deducted currently.. Section 1305 is identical to the provision in the House bill, except for clarifying technical changes and its extension to cover p-rofessional authors.

II. Need for Le2islation

The need for the proposed legislation arises from

the Internal Revenue Service's pronouncement in Revenue Ruling 73-395 on September 24, 1973, that publishers could not currently deduct expenditures incurred in writing, editing, design and art work, which were directly attributable to the


development of textbooks and teaching aids. The ruling held that such costs must be capitalized, and amortized over the useful life of the copyright of the book for which such expenditures were made, unless the taxpayer were able to prove a shorter useful life for the book.

Although the ruling affected the entire publishing industry, it was issued without prior notice and opportunity for industry comment. The publishers' accounting practices for these costs have, in many cases, been consistently followed for more than 50 years, have been approved by competent, reputable accounting firms, and have, until recently, been approved by IRS audit personnel either tacitly by not raising the issues, or explicitly by dropping the issue after it was raised.

The extent to which the ruling would alter the dominant industry methods of accounting was clearly revealed by a recent Ad Hoc Committee survey of the tax treatment of prepublication expenditures. The segments of the industry covered by the Ad Hoc Committee survey included some forty publishers of elementary and secondary school textbooks, college textbooks, technical, scientific, medical and business books and subscription reference books (primarily encyclopedias). Publishers of these types of books represent over 50 percent of the total publishing industry sales, and are those which have been most directly affected by the IRS ruling. The companies which responded to the Ad Hoc Committee survey account for some 83 percent of the dollar sales of the publishers in the surveyed


segments of the Publishing industry. A detailed analysis of this survey was given several months ago to the Joint Committee Staff, to the Finance Committee Staff and to the Treasury and the Internal Revenue Service.

The Ad Hoc Committee survey showed that there has been a substantially uniform practice among publishers of currently expensing all "editorial" and "production" expenditures (primarily art, design, purchasing and administrative functions), with the possible exception of expenditures for editorial and production work performed under contract by outsiders. Approximately one-sixth of the responding publishers indicated they employ some method of deferral for outside editorial and production costs. With respect to "plant" costs (primarily outside artwork, composition, negatives and plates), about one-third of the responding companies have currently expensed those amounts, and about two-thirds of them have written the amounts into inventory or amortized them over a number of years. 'The substantial uniformity-of publishers expensing prepublication -expenditures, particularly editorial and production costs,, as'revealed by the survey, underscores the inequity of the sudden reversal of IRS audit practice by its issuance of Revenue Ruling 73-395.

The results of this survey demonstrate that the compulsory retroactive change attempted to be imposed by Revenue


Ruling 73-395 affects a large segment of the industry. Over one-third of the responding companies reported that the IRS has challenged the company's income tax accounting for one or more categories of prepublication expenditures. Since many companies still have back years open for audit, the number of companies directly affected could be far greater if Section 1305 is not enacted. Thus, this is clearly an industrywide problem.

The costs which the ruling asserts to be not currently deductible are the publishing industry's equivalent of the research and development expenditures that are paid or incurred by other business taxpayers in the creation of new products. They include salaries and fees paid to employees and consultants who design, edit, illustrate, compile and revise the books and teaching aids published by the industry. Like any other industry which must develop and market its own products, the publishing industry's development expenditures are a normal and recurring cost of doing business. Many of these expenditures in any event should be deductible under Section 162 as ordinary and necessary business expenses. In

*/ Compare Revenue Procedure 69-21,, 1969-2 Cum. Bull. 303 in which the IRS ruled that the costs of developing computer software in many respects so closely resemble research and experimental expenditures within the purview of Section 174 as to warrant accounting treatment similar to that accorded under Section 174.


enacting Section 174 as part of the 1954 Code, Congress intended to eliminate controversy as to whether a particular expenditure for research, product development and the like is or is not covered by Section 162. Nonetheless, the ruling arbitrarily singles out and excludes the publishing industry from expensing these amounts, and thereby increasing the cost and discouraging the development of publishing textbooks, reference works and teaching aids, thereby penalizing school systems, students and every American who reads.

Because it represents such an abrupt change in tax accounting practices, the ruling has created considerable confusion in the publishing industry, posing questions as to potential retroactive tax liability for amounts spent on books already published and creating uncertainty as to the proper handling of the costs of publications to be undertaken in the future. Since the promulgation of the ruling, IRS auditing agents have proposed disallowing deductions previously consistently taken by a number of publishers in their development of new books. However, it appears that no two audits have resulted in selection of the same expenses for capitalization or an equivalent amortization treatment of items capitalized. Indeed, in each case to date in which the ruling has been invoked on audit, it has been applied in markedly different ways. The impact of the ruling on a

74-659 0 76 4


publisher now seems to depend greatly upon the location of the IRS office responsible for the audit.

Despite the longstanding practice of current deduction of prepublication costs shared by most of the Publishing industry, the IRS insisted that the ruling reversing that practice be applied retroactively. On February 11 of this year, despite earlier votes by the House and by the Senate Finance Committee approving legislation to end the retroactivity, the IRS National Office instructed a field office to proceed with enforcement of retroactive tax assessments under the ruling. A subsequent IRS press release of March 11, 1976, which announced the suspension of audit and appellate activity under the ruling pending the completion of a project to re-examine the matter, does not obviate the need for prompt enactment of this legislation, since the IRS has given the industry no assurance that it will alter its insistence on the retroactive application of the tax rules announced in the ruling.

III. Legislative Solution

Section 1305 merely provides a "do-not-disturb"

rule to preserve the status quo for the period before a longrun solution is put into effect. Under this legislation, for the period before regulations for the future go into effect, a taxpayer is allowed to treat his prepublication expenditures in the manner in which he consistently treated them before the issuance of Revenue Ruling 73-395.


The publishing industry will continue its cooperation with the Joint Treasury IRS Task Force that is studying the problem and attempting to develop a permanent administrative solution to be applied prospectively. However, if the Task Force is unable to devise an adequate administrative solution, the industry will be forced to seek a permanent resolution of the problem by means of additional legislation.

IV. Revenue Effect

No revenue loss will result from enactment of the stop-gap legislation. Rather, the legislation will prevent the IRS from retroactively producing tax revenue by administrative action from a source never intended by Congress. The House Ways and Means Cor=ittee report to the House on the legislation as passed by the House in December, 1975, stated that no revenue loss will result, and the Finance Committee Report on H.R. 10612 (p. 405) confirms that little or no revenue loss is involved.

V. Status of the Legislation

The Association of American Publishers and the Ad Hoc Committee requested the opportunity to testify on this subject before the House Ways and Means Committee in July, 1975, in its hearings on tax legislation that became H.R. 10612, but were not called to testify. In lieu of oral testimony, a statement in support of H.R. 8736 (identical to S. 2340)


was filed, and appears in the printed transcript of-thd' Ways and Means hearings on the subject of tax reform (commencing on page 839). The Committee on Ways and Means did not adopt a permanent solution to the problem, but in its open mark-up sessions in October 1975 did approve the stop-gap do-not-disturb provision which was passed by the House on December 4, 1975, as Section 1306 of H.R. 10612.

The Association and the Ad Hoc Committee made written request to testify before the Finance Committee in connection with its public hearings on H.R. 10612, but were not called to testify. Accordingly, they filed with the Finance Committee a written statement dated April 23, 1976, in support of this provision. The statement was referred to in the Staff pamphlet dated April 30, 1976, summarizing statements that had been

submitted (p. 32) .

The provision was considered by the Finance Committee in an open mark-up session on May 27, 1976, and was approved with technical clarifying changes and an extension to cover professional authors.

Thus Section 1305 has been under public consideration and discussion approximately a year, statements in support of it have been filed in hearings before both Committees and it has received the approval of both Committees in open mark-up sessions.

A 1%

VI. Conclusion

For the reasons stated above it is respectfully

submitted on behalf of the publishing industry that Section 1305 as previously approved by the Committee on Finance, at least as it applies to publishers, should be enacted.



July 21, 1976

Before the Committee on Finance
United States Senate

Statement of The Authors League of America


Deduction of Authors' Research and Other Expenses: Sec. 1306, H.R. 10612

Mro Chairman and Members of the Meeting:

My name is Irwin Karp. I am Counsel for The Authors League of America, the national society of professional writers. I respectfully request that this statement by The Authors League be included in the record of the Committee's hearings on H.R. 10612.

This statement concerns the tax treatment of research, travel and
similar expenses incurred by professional authors in gathering information, preparing and writing books and other literary works. As the Courts have ruled, these are ordinary and necessary expenses of the professional author's trade and business of writing which he is entitled to deduct in the year they are incurred. However, a 1973 Ruling by the Internal Revenue Service disputes that right. Section 1306 (H.R. 10612) would suspend application of the Ruling to professional authors, and to publishers.

The Authors League respectfully urges that Section 1306 be approved by the Committee on Finance and adopted by the Senate. We should stress that the Section does not grant professional authors new rights. On the contrary, it preserves rights which the Courts have held they possess.


In 19719 a District Court opinion reaffirmed the right of professional authors to currently deduct research and similar expenses incurred by them in preparing and writing books and other literary works. Stern v, United States, 1971-1 USTC 86,419 (Par. 9375). Professional authors had long followed this practice. Courts upheld it.

The IRS did not appeal the Stern decision. Instead, it issued
Revo Rul. 73-395, contending that these "prepublication expenses" could not be currently deducted by publishers, and had to be depreciated over a period of years The Ruling concludes with a refusal by the IRS to follow the Stern decision and has been applied to authors.

Sec. 1306 of the House Tax Reform Bill, also submitted as an amendment by Senator Bentsen, suspended application of the Ruling with respect to publishers. Professional authors were not protected by the Section, although the Ruling is aimed at a decision that correctly upheld their right to deduct these expenses in the year incurred.


Your Commu!ittee amended Section 1306 to also apply it to authors
engaged in the trade or business of writing. The Authors League had, on April 20, 1976, submitted a statement to the Corunittee urginC that amendment. It should be noted that Section 1306, as thus amended, would apply only to professional authors, i.e. those engaged in "the trade or business of writing"; this criterion is often applied by the IMS and the courts in distinguishing professional authors from amateurs under various sections of the Internal Revenue Code.

A recent "News Release"l by the IRS announces it will "suspend audit and aT~nellate activity with respect to cases in which the deductibility of these prepublication expenses is an issue" pending completion of a "project" which may lead to new regulations or additional rulings. However, the release is limited to publishers. And it leaves professional authors completely in the dark as to the position the IRS would take if they continued to currently deduct research, travel and similar expenses, as the Courts have ruled they are entitled to do.

Reasons for Adopting Section 1306

Wi In the case of novels, histories, biographies and other books of general interest, it is the self-employed author, not the publisher, who pays the travel, research and other expenses incurred in gathering information and material for a book. As the Court indicated, in Stern v. U.S., these expenditures are not non-deductible expenditures for the improvement of a capital asset (whi7Fimust be depreciated). On the contrary, ruled the Court,

"(these) expenses were ordinary and necessary expenses
of carrying on plaintiffs business of a writer and
hence are deductible under 26 U.S.C. 162(a). See
Dof~ettv. Burnet (65 F2d 191); Brooks v. C.I.R.
(274F.2d 96.)1

Travelling to conduct interviews, consulting research sources and similar preparatory work are as much part of the process of writing a book as are putting the words down on paper. The expenses of doing this work are ordinary business expenses*

(ii) It is totally inconsistent to rule that these ordinary business expenses must be capitalized and depreciated. Sec. 1221(3) of the Internal Revenue Code prohibits authors from treating their literary, dramatic and musical works as "capital assets." In this and other sections, authors are held to be persons who earn "ordinary income" by their personal efforts. As this Committee stated in regard to Sec. 401 (c)(2)(C), "income from an author's writing ... is (so) clearly a result of his individual efforts."t

(iii) An author must pay his research and travel expenses as they are incurred. And he does not have the financial resources to spread their deduction over a period of years through depreciation. If he cannot deduct them in full in the year they are incurred, he suffers a much harder financial blow than a publishing corporation. Moreover, these prepublication


expenses usually are incurred during the same period that the author receives compensation from the publisher (in the form of an "advance") from which he pays these expenses. This compensation is fully taxable to the author at the time of its receipt.

We thank the Committee for the opportunity to submit this statement.

The Authors League of America

By: Irwin Karp, Counsel




For over fifty years, the holders of face-amount certificates have been taxed on the interest element in the certificates when they received the proceeds of the certificates either at maturity or earlier surrender.

The holder is typically a cash-basis taxpayer. It is sensible for him to pay the tax on the interest when he receives the interest.

The Internal Revenue Service considers that the 1969 Act changed the law to require these cash-basis taxpayers to pay tax each year on the interest in their certificates as it accrues. Requiring ratable payment will adversely affect the sale of face-amount certificates.

The Committee amendment clarifies the law to
restore the long-standing treatment of taxing holders of face-amount certificates when they receive the proceeds of their certificates.



Mr. Chairman:

My name is Kenneth R. Wahlberg. I am President of
Investors Syndicate of America, Inc. whose headquarters are in Minneapolis, Minnesota.

Investors Syndicate of America, Inc. is engaged in the business of issuing face-amount certificates. Under an installment certificate, the certificate holder makes installment payments over a period of 30 years; upon maturity of the cer-tificate, the holder is entitled to receive an amount equal to its face amount which is the cumulative installment payments plus an interest element.

At the present time Investors Syndicate of America,
Inc. has face-amount certificates outstanding in the amount of $2.2 billion.- At the end of 1975 there were approximately 250,000 persons holding these face-amount certificates. The sales of new certificates in 1975 equaled approximately $468 million in face amount.

From the time the 1954 Code was enacted until the 1969 Act, the tax treatment of payments by the issuing company to the holder of a face-amount certificate was very clear. The rule was that a face-amount certificate was to be treated for federal income tax purposes in the same way as an endowment contract under 72 of the Code. This treatment is confirmed by the specific statement in 72(l) that "the term 'endowment contract' includes a face-amount certificate." Consistent with 72(l), it is provided in 1232 that face-amount certificates are not to be treated as original issue discount paper under that Code provision; 1232(d) states that "for special treatment of face-amount certificates on retirement, see section 72."

When the 1969 Act was enacted there was nothing in the law itself or in its legislative history that indicated that Congress, in any respect, had in mind face-amount certificates when it made changes in 1232 affecting original issue discount bonds. In fact, since the amendments to 1232 did not expand the scope of that-Code provision, nor change the language of 72(l) and 1232(d), it appears that Congress did not intend to


change the taxation of face amount certificates which historically have been separately defined and separately treated by the Code.

Our problem arises because the Treasury, relying upon the 1969 Act, amended its regulations to tax face-amount certificates under 1232, thereby requiring a certificate holder to include in taxable income each year his ratable part of the interest element that he will not receive until the certificate matures at the end of 30 years.

Since Congress appeared to have no intent to change
the treatment of face-amount certificates in the 1969 Act, we asked your Committee to confirm our understanding of the state of the law. We asked that the tax reform bill provide that the taxation of face-amount certificates is to continue as it had existed during the period 1954 through 1969.

The committee amendment clarifies 1232(d) of the
present law to provide that face-amount certificates are not subject to the rules under 1232, but rather are to be taxed under 72. As a result, the interest element in a face-amount certificate would not be ratably included in the gross income of the holder over the term of the certificate since a typical certificate holder is on a cash basis. Instead, the interest element would be included in the gross income of the holder upon actual receipt by him, either at maturity of the certificate, or upon an earlier redemption.



Summary of Principal Points of Testimony
of Dr. N. Jay Rogers, Partner,
Texas State Optical Co. (TSO)

1. TSO is a partnership for the practice of optometry and
sale of eyeglasses and frames with approximately 128 outlets, some of which have been sold, and some owned in
partnership with managing optometrists.

2. TSO advertises its services and provides low cost eyecare.

3. General advertising and small size of outlets dictates
certain controls being imposed %:hich have resulted in
adverse tax impact.

4. 1969 franchise transfer tax law directed at fast food
outlets dictates ordinary income treatment for income
from transfers of franchise, trademarks, and trade names,
rather than capital gains.

Contrary to almost invariable practice, the law failed to consider binding contracts entered into prior to the
date of enactment based on previous law.

6. The Committee on Finance passed an equitable grandfather
clause amendment which we support applying to transfers
of professional practices.

7. Another part of the amendment adopted closes off capital
gains treatment of a franchise transfer to a partnership and
then the sale of a partnership interest, thereby otherwise
circumventing 1969 franchise tax provision.


Testimony of Dr. N. Jay Rogers On Section 1311 otE H.P. 10612
Relating To Certain Franchise Transfers

Thank you, Mr. Chairman, for allowing me the opportunity to express my views on section 1311 of H.R. 10612, relating to the transfer of certain franchises. My name is Dr. N. Jay Rogers and I am a partner in the firm of Texas State Optical (TSO), a partnership which operates in Texas and Louisiana. TSO is owned by myself and my brother. We started our optometry practice in 1936, and have, over the years, opened approximately 128 outlets, usually also connected with the sale of eyeglasses and eye frames. From about 1944 to the present we sold approximately 60 of these outlets. we operate 39 others in partnership with the optometrists who operate the offices, and own the other 29 outright.

over the years, we have been able to provide to our customers inexpensive but quality eye care, eyeglasses, and prescriptions. In fact, because of the way we operate, we have been able to furnish these glasses and prescriptions at a price which is significantly below what would be charged in most other areas of the country. One of the methods we use in providing this is to have an extensive program of advertising. This program obviously benefits all of the outlets in the advertising area, with the result that we must require all outlets to participate in the advertising. We were innovators in the advertising of eyeglasses and eye frames, something which the Federal Trade Commission has recently adopted as one of its recommended policies. However, because of our advertising operation, and the small size of our outlets which dictate certain controls being imposed for good business purposes, we have


been adversely affected by a tax provision which was adopted by the Congress in 1969 and which became effective the following year.

Prior to 1970, if someone transferred a franchise, trademark, or trade name to another person, the character of any gain recognized on the transaction would be subject to the normal tax rules. Under these rules, some situations would give rise to ordinary income treatment and others would result in capital gains treatment. In 1969, Congress adopted a provision aimed at the fast food industry which became effective in 1970 which mandated ordinary income treatment for all of these transfers. In doing so, however, it failed to take into account that taxpayers might have already entered into binding contracts and would be caught in this amendment. As you knew, qererally "grandfathers" binding contract situations when they adopt rules which change the tax law. Because this was not done for this change, the economics of our transactions covered by these contracts were significantly and adversely affected. They obviously had been negotiated under the prior law, which we believe in our situation would have given rise to capital gains treatment. Instead, because of the law change, we now find ourselves having binding contracts with prices which presume capital gains treatment but which now may result in ordinary income treatment. Most of these contracts were not entered into in 1970 or subsequent years but in 1968 or earlier years.

When our accountants called this situation to our attention, we gave considerable thought to whether or not to petition the Congress, as is our constitutional right, to consider our situation,

- "L. r,


and decided to ask for the adoption of an equitable grandfather clause which would take into consideration 'that certain binding contracts had been entered into before 1970. We rejected an approach which we felt equitable, after consultation with the congressional staffs, that would have excluded all professional practices from these rules which were originally adopted because of abuses in the fast food franchise area. Obviously, when this provision was first adopted nobody thought that professional practices and businesses connected thereto would be swept under this provision. In order to correct this inequity which we pointed out, the Committee on Finance adopted a provision which grandfathered those contracts entered into before 1970, which were entered into with employees or partners of the transferor, and which involved the transfer of a franchise, trademark, or trade name which was connected with a business in which a professional practice is involved. It is my opinion that this is a very sound approach. These tests cover those situations which Congress found deserved attention but at the same time are restrictive enough so that they do not cover situations which, if brought to the attention of Congress, would be considered inequitable.

The Committee also adopted as part of this section a reform provision which has the effect of denying taxpayers a method of avoiding the ordinary income treatment provided under the franchise rules. It is possible under present law for taxpayers to transfer a franchise, trademark or trade name to a partnership and then sell the partnership interest and receive capital gains therefrom, rather than deriving ordinary income if this sale had been made directly to the purchaser. TSO has opinion of counsel that certain of our transactions would also be covered by this


provision. We recognize that Congress may want to close this avenue of avoiding the franchise rules, and accept the Committee's decision on this point. We would, however, like to point out that the effect of this entire provision is to drive the price of these outlets up for very small entrepreneurs who are trying to establish a business. Furthermore, we might also point out that these rules were originally developed for problems which had arisen in the fast food franchise area and nobody at the time thought they covered the sale of a professional practice.

Because of situations like this, it is our opinion that the

Committee on Finance is doing a commendable job in reviewing broad based legislation subsequent to its enactment in order to determine if the legislation should be changed to cover situations that were not covered under the original draft or to exclude equitable situations which should not have been covered but which were because of the breadth of the statute.

On my behalf and for my brother, I wish to state we seek no unfair tax advantage, but we respectfully ask what is wrong with our requesting that an obvious legislative oversight be corrected by the addition of a binding contracts clause, a provision common to almost every tax law change.




JULY 22, 1976



Mr. Chairman In behalf of our General President, Edward T. Hanley, and the 500,000 members we are proud to represent, We are gratified at the opportunity to appear before your Committee to discuss a matter of vital importance to our International Union. First of all we would like to extend our thanks to the Committee for their thorough deliberation of the tip income issue which culminated in a clarifying amendment being overwhelmingly adopted on May 27, 1976. The merits of this issue today are as strong as they were when this Committee adopted the aforementioned amendment. I am pleased to appear today in behalf of a Union which represents a half million members, approximately 25 percent of whom are classified as tipped employees. We also realize our appearance in this matter will assist thousands and thousands of tipped employees who are not part of the organized labor movement. Our members, as well as the working people of America, are in fact our "Special Interest."

Mr. Chairman, tipped employees have been covered under the Fair Labor Standards Act since 1966. The system created by the Congress heretofore has been fair. It required the employee 1-o keep track of his own tips, report them to the employer in writing, and be taxed and subjected to withholding on them as so reported. Last year the Internal Revenue Service promulgated Revenue Ruling 75-400, which was subsequently superseded in May, 1976, by Revenue Ruling 76-231. Unless there has been a change in our constitutional process that I am


unaware of, we are laboring under the impression that Congress is the legislative branch of the government and is supposed to create laws, and the Internal Revenue Service is part of the Executive Branch of government which is supposed to implement the laws. There has not been a change regarding the area of tipped income since the Fair Labor Standards Act of.1966 covered tipped employees for the first time. The Legislative intent and the legislation itself is clear. Revenue Ruling 75-400 and subsequently 76-231 apparently make no effort to take into account existing law. The clarifying amendment which your Committee overwhelmingl-. adopted on May 27, wisely reiterates the law as written by the Congress of the United States.

Due to the Revenue Ruling, Mr. Chairman, there was another unfortunate development which occurred. In many cities our members are on a checkoff system, which means that by signing a form they authorize the employer to deduct union dues from their payroll check, and these monies are forwarded to the union. A matter such as this is spelled out in a duly negotiated collective bargaining agreement between labor and management. We received word from our local union in Minneapolis, that due to the Revenue Ruling our members received payroll checks which were so low, and some which were even blank, that the employer could not deduct uni6n dues and was telling the union that they would have to go to the member directly and get the union dues themselves. So a further consequence of these Revenue Rulings has been in some instances to abrogate a collective

bargaining agreement which has been duly and legally negotiated between


labor and management. Again, here we have an intrusion into the sacrosanct area of collective bargaining agreements by an agency of the Executive Branch with no regard for existing law or any negative consequences that might be engendered. When H.R. 6675 was passed in 1965 specifically covering the taxation and reporting of tip income, the whole subject was treated and the legislative history from that time makes it clear that the reporting burden should properly be on the employee. The legislative history included the following statement:

"...the only equitable way of computing tips toward benefits is on the basis of actual amounts of tips received and that the only practical way to get this information is to require employees to report their tips to the employer."

With this in mind Mr. Chairman, we sincerely believe that there is no basis for the recent ruling of the Internal Revenue Service regarding the handling of tipped income. It is our strong feeling that the Committee wisely adopted, after very thorough debate, the clarifying amendment on May 27, 1976. We appear here today in behalf of all of our gratuity employees and all others affected by this matter and urge strongly that the Committee adhere to the amendment which they adopted by an overwhelmingly vote and is now a part of H.R. 10612.






BILL SECTION 1312, H.R. 10612

1. The amendment in Committee Bill Section 1312: Clarification of an Employer's Duty to Keep Records and to Report Tips, does not bestow any tax benefit on any employer or employee; nor does it free employers from reporting tip income received by their employees.

2. In enacting the 1965 amendments to the Internal Revenue Code, Congress decided that the only practical way to determine actual tip income for tax purposes was to require the employee who receives the tips to report the amount received to his employer. Section 6053 was added to the Code in 1965 for this purpose.

3. Congress also recognized the common practice of tip splitting and tip pooling and determined that only pips received by an employee in his own behalf would constitute wages or income to that employee. Any portion of a tip which an employee splits or gives to a tip pool is income to the ultimate recipient. As a result of this determination, section 6051 of the Code was amended in 1965 to provide that an employer's report of tip income on Form W-2 "shall include only" that tip income reported by the employee to his employer.

4. The legislative history of the 1965 amendments shows that Congress was fully aware of the practices and customs of tipped employees, and was deeply concerned that employers reporting and record-keeping requirements be minimal.

5 For nearly a decade employers'and employees have followed these procedures as prescribed in the law and as clearly intended by Congress.

6. The need to reaffirm and clarify Congress' intention to limit the employer's tip income, record-keeping, and reporting burdens to only that tip income reported by the employee arises from an IRS ruling that would require employers to keep a record of all charge tips passed over to each employee and to reflect the total amount on the Form W-2, whether or not this amount had been reported by the employee.

7. Compliance with this ruling would be inconsistent with the law and Congressional intent; would impose a new and extensive record-keeping and reporting burden on employers; would unjustifiably impugn the honesty of many thousands of tipped employees; and would create a source of conflict between employer and employee.


Mr. Chairman and members of the Committee:

The National Restaurant Association and the American Hotel and Motel Association are the principal trade associations in the foodservice and hotel-motel industries. We both have the firm support of our large nationwide membership in urging the enactment of Committee Bill Section 1312: Clarification of an Employer's Duty to Keep Records and to Report Tips (sec. 1312 of the bill and secs. 6001 and 6051 of the Code.)

At the outset it should be noted that this amendment does
not bestow any tax benefit on any employer or employee; nor does it free employers from reporting tip income received by their employees. The amendment simply states the intent of Congress as reflected by.the legislative history surrounding the 1965 amendments to the Internal Revenue Code.

The need for this clarifying amendment arose in this way.
From the inception of the tax laws in 1917 until 1965, employers were not involved in reporting on or withholding taxes related to tip income. Employees were merely required to report their tips and to pay taxes thereon on a calendar year bas is. In 1965, however, Congress changed all this by making employers responsible for including tip income on employees' earnings reports (Form W-2) and for withholding income and social security taxes thereon. The legislative history demonstrates that Congress did not do this lightly. It spent several years studying and planning the administrative provisions governing the taxation and reporting of tip income. These provisions reflect the Congressional concern to minimize to the maximum degree possible the burdens placed on employers in reporting and withholding taxes on tip income.

In establishing the employer's responsibility to report and withhold taxes on tip income, Congress confronted and resolved troublesome issues, two of which are especially important here. The first of these arose because of the pervasive practice of tip pooling and tip splitting among tipped employees in the restaurant and hotel-motel industries. Congress recognized these practices and determined that the tax burden should fall upon the ultimate recipient of the tip.

Only tips received by an employee on his own behalf
and not on behalf of another employee constitute wages.
Thus, where employees practice tip splitting, the ultimate
recipient of the tip (or portion thereof) is the employee
who is receiving the tips as wages. [H.R. Rep. No. 213,
89th Cong., lst Sess. 219 (1965).]"

Recognizing the nature of the tipping transaction, a second principal issue was how does the employer determine the amount of tip income on which to report and withhold taxes? Congress concluded that:


"The only equitable way-of counting tips ... [would be]
on the basis of actual amounts of tips received and that the only practical way to get this information [would be] to require employees to report their tips to the employer.
[H.R. Rep. No. 213, 89th Cong., 2d Sess. 96 (1965).]"

Following this logic, Congress added a new section 6053 to the Code which requires employees to report tips received on their own behalf by the 10th day after the month in which they are received. Section 313 of Public Law 89-97 effected corresponding changes to the income tax withholding provisions (sections 3401 et sequi), the social security tax withholding provisions (sections 3101 et sequi), and the general reporting provision (section 6051) of the Internal Revenue Code to make reporting and withholding of social security and income taxes on tip income "applicable only to such tips as are included in a written statement furnished to the employer pursuant to section 6053(a)." Finally, Congress amended section 6051 of the Internal Revenue Code to similarly limit the amount of tips to be shown on the annual statements which employers prepared for employees to reflect income and withholding during the year (Form W-2). As amended in 1965, section 6051 provides:

"In the case of tips -received by an employee in the
course of his employment, the amounts required to be
shown ... shall include only such tips as are included
in statements furnished to the employer pursuant to
section 6053(a)." (Emphasis added.]

We see no reason to burden the Committee with an extended expedition through the Code and Treasury Department Regulations to establish that under the Code and the regulations the Form W-2 constitutes the only report of wages, compensation, remuneration, and income paid to employees which is required to be made by an employer. This is not disputed. As you are all aware, copies of the Form W-2 are supplied for IRS and to the employee for his records.

For nearly a decade after the enactment of the 1965 amendments to the Internal Revenue Code, employers followed the prescription of section 6051 and withheld taxes on and reported only that tip income reported by their employees. Then, in 1975, without any change in the law, IRS issued a ruling (Rev. Rul. 75-400) which required the employer to keep a record of all charge tips which he pays over to an individual employee and to report the sum total of those charge tips on that employee's Form W-2. This sum total of charge tips was to be reported to IRS whether or not the tips had been reported by the employee and without regard to the identity of ultimate recipients of the tip through tip splitting and pooling arrangements. We contested this ruling with IRS, without success. Our contention was and is that the ruling is inconsistent with the intent of Congress when it enacted the amendment to section 6051 of the Internal Revenue Code in 1965 which requires that the amount to be reported as tips "shall include only such tips as are included in statements furnished to the employer pursuant to section 6053(a)." We were and are now


also deeply concerned that, due to the practice of tip splitting and tip pooling, assigning the entire charge tip to an individual employee will require the employer to knowingly make a false, inaccurate report. That such reports will result in conflicts between the employer and his employees an unjustifiable reflection upon the honesty of our industries' employees are also disturbing probabilities. While the Committee was considering an amendment to clarify this matter, IRS issued a new revenue ruling (Rev. Rul. 76-231) which, while more detailed than its predecessor, continues the same burdensome requirement.

As we understand it, the Internal Revenue Service finds its authority to circumvent section 6051 of the Code in section 6041. Section 6041 provides that,
11all persons engaged in a trade or business and making
payment in the course of such trade or business to another
person, of rent, salaries, wages, premiums, annuities,
compensations, remuneration, emoluments, or other fixed
determinable gains, profits, and income ... of $600 or more in any taxable year, ... shall render a true and
accurate return to the Secretary or his delegate...
setting forth the amount of such gains, profits, and income, and the name and address of the recipient of
such payment."

We believe that section 6051 of the Code and the legislative
history of the 1965 amendments make it eminently clear that Congress intended to limit an employer's obligation to report tip income to, 11only such tips as are included in statements furnished to the employer pursuant to section 6053 (a)." and that section 6041 does not apply. We base this conclusion on the following facts:

a. The entire legislative history of the 1965 amendments as it relates to taxing and reporting tip income reflects a thorough understanding by Congress of the practices and customs of tipped employees and a deep concern for the accounting problems these amendments would present to employers. This concern was reflected in the House Committee Report in these words,

"The employee would be required to report to his
employer in writing the amount of tips received and
the employer would report employees' tips along with
the employees' regular wages... A provision is included
under which the Secretary of the Treasury or his delegate is authorized to issue regulations under which the employer will be permitted to gear these new reporting procedures into his usual payroll. It is the understanding
of your Committee that regulations will be issued
along these lines to the end that the procedures required
of the employer with respect to this reporting requirement will be minimal." (House Report No. 1548, 88th
Cong., 2d Sess. 11 (1964) (Emphasis added.)]

b. One cannot argue that Congress did not anticipate or have knowledge of charge tips as opposed to tips received directly


from the customer, for the House Committee Report specifically refers to charge tips in these words,

"The employee would be required to report to his
employer in writing the amount of tips received and the employer would report the employee"s tips along
with the employee's regular wages. The employee's
report to his employer would include tips paid to
him through the employer as well as those received directly from customers of the employer." [House of Representatives Report No. 312, 89th Cong., lst
Sess. (March 29, 1965) (Emphasis supplied.)]

c. As mentioned above, Congress clearly established that
only tips received by an employee on his own behalf and not on behalf of another employee constitute wages." Yet, IRS relies upon section 6041 to require employers to keep independent records of charge tips paid directly to each employee and to reflect this amount on the Form W-2, even though in most cases a portion of that amount will not fall within the terms of the salaries, wages, compensation, and remuneration to which 6041 applies. We should also note that the transfer by the employer to the employee of the amount designated by the customer on the charge slip does not constitute a "payment" by the employer within the meaning of section 6041 any more than a meal charged on a credit card account constitutes a sale of the meal to the company issuing the credit card. The employer is nothing more than a conduit through which the payment passes from the customer to the employee, just as a bank is a conduit when it cashes a check.

d. Section 6041 upon which the IRS relies makes no mention of tip income. Since section 6041 preceded section 6053 and the 1965 amendment to section 6051 limiting the employer's reporting obligation to that tip income reported by the employee under section 6053, the more recent and specific requirements of sections 6051 and 6053 clearly supersede the earlier general requirements of section 6041. Further it is abundantly clear from the legislative history that Congress was concerned that the employer's record keeping and reporting obligations not become burdensome and that it was fully aware of the problems posed by tip splitting and pooling. Congress did not intend that the employer be saddled with a reporting and record keeping burden of the nature which IRS now seeks to impose. It was the intent of Congress that sections 6051 and 6053 control the matter of reporting tip income.

The amendment in Committee Bill Section 1312-will serve to reinforce and clarify the plain intent of Congress when it passed the 1965 amendments and preclude the imposition of a requirement which is unduly burdensome and expensive for employers; creates a source of conflict between employer and employee; and unjustifiably calls into question the honesty of many thousands of tipped employees.

We respectfully urge the Committee to reaffirm its adoption of Committee Bill Section 1312.


ON SECTION 1317 OF H.R. 10612

July 22, 1976

Mr. Chairma~n and Memnbers of the Commnittee:

My name is Daniel M. Davis. I am a Vice President of The First National Bank in Dallas. I am accompanied by Robert L. Bevan, an Associate Federal Legislative Counsel of the Amrerican Bankers Association. The Ame~rican Bankers Association is an association ccuoosed of about 14,000 banks or sarm 96% of the banks in the country. Approximately 4,000 of the banks exercise fiduciary powers serving their custcirs as trustees and executors. Thus, the Association is keenly interested in any changes in the tax laws affecting trusts and estates.

The list of subjects to be considered at these hearings includes Section 1317 of H.R. 10612 which is now before the Senate. This Section contains needed amrendments to section 613A of the 1954 Code which was enacted as part of the Tax Reduction Act of 1975. The ABA is particularly concerned with the amrendments proposed in subsection (b) of Section 1317, which relates to trusts. We strongly support these amendmrents, which do nothing more than cure inequities in our tax law, but also recommrend for reasons I will mention that additional action be taken by your Commrittee to cure other inequities.


Section 613A eliminates the percentage depletion deduction for oil and gas produced on or after January 1,, 1975 subject to certain exceptions which include a so-called "small independent producer" exemption. In order to prevent fractionalization of interests and the multiple use of the exemption, section 613A(c)(9) provides that the exemption is not available "in the case of a transfer . after December 31, 1974 of an interest (including an interest

in a partnership or trust) in any proven oil or gas property" except "a transfer of property at death" or a transfer in a section 351 exchange. This provision is uncertain in scope and if applied literally produces inequitable results in the case of "transfers" of oil and gas interests by trusts and estates.

Section 613A(d) is even worse. It provides that the depletion deduction for small independent producers cannot exceed 65% of the taxpayer's "taxable inomie" for the year involved ccoputed without regard to depletion and certain other items. The use of

"taxable income" is inappropriate for a trust because in arriving at this amount distributions to beneficiaries under sections 651 and 661 are deducted. The law of many states requires a trust to

add an amount equal to the depletion deduction to principal. In such cases the trust would, before the enactment of section 613A(d), have had no "taxable income" because the deduction would have offset the retained income. Under section 613A(d), the trust will now have to pay a tax as a result of a disallowance of 35% of the depletion

deduction. To disallow a part of the deduction and to produce a tax


at the trust level without adding back the section 651 and 661 deductions is grossly unfair.

During Decemiber 1975 the ABA filed commrents with the Ca~ussioner

of Internal Revenue on the proposed regulations to section 613A dealing with some of its defects. A copy of these comments is filed with this statement. No mention was made of section 613A(d) because of our belief that its inadequacy as to trusts could only be solved by amending the statute.

The amendmrents recommended by Section 1317 to section 61 3A (c) (9) and section 613A (d) would alleviate somre of the inequities referred to above by providing that in applying section 61 3A (d) to a trust the 65% limitation would be com~puted before taking into account any deduction for distributions under sections 651 or 661, and by amending section 613A(c) (9) to provide that a change of beneficiaries of a trust by reason of the "death, birth, or adoption of any beneficiary if the transferor was a beneficiary or is a lineal descendant of the grantor or any other beneficiary". The change in section 613A (c) (9) is too narrow and does not solve other prblm that exist in applying the "transfer" rule to trust and estate dispositions and which are referred to in our comments on the proposed regulations to section 613A.

We urge your Caimnttee to approve additional changes in this section which will solve all of the problems referred to in our cxrtments filed with the Comissioner. We note that the report of the Finance committee on H. R. 10612 states that the transfer rule was not intended to apply to "sanre cases of transfers which occur by operation of law". This intent should certainly exempt transfers

74-659 0 76 6


from pre-existing trusts from the scope of 6 13A (c) (9).

Mr. Chairman, we also submnit with this statement a

nmrorandum. on the following provisions of H.R. 10612, as reported:

1. Tax-Exempt Annuity Contracts (Section 1505).

2. Swap Funds (June 11 Commrittee action).

3. Extension of Study of Salary Reduction and Cash

or Deferred Profit-Sharing Plans (Section 1507).

4. Extension of Time to Conform Charitable Remiainder Trusts for Estate Tax Purposes (Section




1. Tax-Eempt Annuity Contracts (Sec. 1505 of the Cammittee bill)

Section 1505 of the Containtte bill would add closed-end mutual funds to open-end mutual funds as permissible investments under section 403 (b) of the Code whereby certain tax-exempt employers way purchase tax-sheltered annuities for their employees. The ABA believes that just as the distinction between open-end and closed-end funds was found irrelevant for purposes of 403 (b) investment, likewise the exclusion of deposit accounts (savings accounts, certificates of deposit and tine-open accounts) is inappropriate.

The tax-exempt emloyer nuaking contributions for 403 (b) purposes should

have the choice of investment in deposits of banks, savings and loans, and credit unions which often offer a more stable and reliable source of retirement benefits than might be true of mutual funds. LImg teim deposit accounts may earn interest at annual rates of 7. 5% and above.

Federal depository institutions offer the additional assurance of federallybacked insurance up to $40,000 as do state insured banks.

2. Swap Funds (June 11 Committee Action)

The Finance Ccxrittee of June 11 regarding the treatment of so-called "swap funds" appears intended to parallel the House approved bill on this subject, H. R. 11920. Assuming that the Finance Commrittee would in fact track the Ho~use language, the Association wishes to point up one result, apparently unintended, which would be totally inappropriate.

The House bill makes clear that the beneficiaries of a trust should not be

allowed to obtain tax-free diversification of portfolio stocks through an exchange for an interest in a caiirrn trust fund. The language of the bill would seem to


make the merger of common trusts funds,, typically occurring subsequent to bank mergers, subject to taxation. Such common trust fund mergers are totally beyond the control of trust beneficiaries and their purpose is in no way to achieve taxfree diversification. Rather their purpose is to achieve efficiency of operation and a reduction in costs. The investment interest of the trust remains basically unchanged. The bill should make clear that such mergers are not taxable events.

3. Extension of Study Reduction and Cash or Deferred Profit-Sharing Plans
(Sec. 1507 of the Committee bill). I

A large number of employees, in banking and other industries,, could be

adversely affected if the current freeze of section 2006 of the Employee Retirement Income Security Act expires without an orderly resolution of tax treatment of salary reduction and cash-deferred profit-sharing plans.

The Association strongly supports the proposed extension of time to complete the study contemplated by ERISA section 2006 since it is virtually impossible to do so prior to the present January 1, 1977 deadline.

4. Extension of Time to Conform Charitable Remainder Trusts for Estate Tax
Purposes (Section 2104 of the Committee bill).

Section 2104 of the Committee bill would mend Code Section 2055 (e) (3) to

extend for two years the time by utdch the governing instrument of a charitable

trust may be amended so as to allow the remainder interest to qualify for the estate tax charitable oantribiution deduction. The complexities of the 1969 Tax Reform Act relative to charitable reminder trusts dictate such time extension to insure fairness to the taxpayers.

The American Bwgwxs Association urges approval of this extension.

July 20, 1976


AMEUiCJ 1120 Cow~vickut PAiemce N.W
BANYLRS %W~hifstoq. D.C.


Deeber 15, 1975

Q-z missioner of Intenmal Revenue
Atenio: M:LRT
Washingtonl, D.C. 20224
Re: Proposed Reguato 51"6m3

Den Mr. Crnsinr

Ine following ca~ments are submtted ax behalf of the
American Bankers Association regarding the ab ~-caotiaed regulation published in the Federal ReVcister of ctober17, 1975 at pages 48691
t~ogh48696. Th-e deadline for cam-ants on the proposed regulation, bas been extended fr= Novenber 17.. 1975 Po .eemer 17, 1975.

Section 63.3A xtinueS the aVa4ilabN4ilit of percentage
d~ltin Mde section 613 to smll Producers (including a trust) subject to certain limitations. One of these lmttIis is t-hat a
*tz~nsfer" (other than a "transfer at death") of the producI Ing= oil
Sgas interest has not beemnade after Deceber 31, 1974. Proposed
reguatin 1. 6M2-7 Wn states:

"fasfer. The tenm 'transfer' mems any change in legal
or egziab~e canership by sale, e~ange, gift, lease, sublease assignment, contract, a cbangje in the 1m-bership of a
p xtrhip or the beneficiaries of a trust.. or other disposition (including any cotrbution, to or any distibution
by a "arporation, parxestp or trast) However, the tenm
&des not include a transfer of property at death (including
a di ribution by an estate) nor an exchange to which section 351 applies (until the tentative quantity detennined mAer the
table contained in section. 613A(c) (3) (ii) ceases to be allocated imder section, 61.3A(c) (8) between the transfer and transferee).
A transfer is deemed to occur on the day on which a binding
.' 11'.7,ct to transfer such property is executed, or.. if no
such =ftract is executed,, on the day on whc the documnt
vdid causes title to the property to pass is executed."


Caissioner of Internal revenue

We believe that for the reasons set forth belcw this definition, as applied to trusts and their beneficiaries, is both tmcertain in operation and too expansive in scope.

Revocable' Trusts
The first sentence of proposed S1.613A-7 (n) refers to "any change in legal * ownership by" certain stated events, including a "gift" or "other disposition". In the past there have been a significant number of cases where merbr banks have acted as trustees of fully revocable trusts consisting in whole or in part of oil and gas interests. A revocable trust is not an independent income tax entity and is ignored for incne tax purposes. All incate received by the trust is considered as incxr-e received directly by the grantor. An =Prortant non-tax reason exists for the creation of such a trust probate costs at the grantor's death (including the expense of ancillary administration for oil and gas interests) that would be incurred if the interest formed a part of his probate (testamentary) estate are avoided. If the interest were a part of the grantor's probate estate, the -transfer at death exception would
be applied.

7he placing of oil and gas interests in a revocable
trust after Deceber 31, 1974 is not a "transfer" after that date for purposes of section 613A because, as a result of the second sentence of proposed Si.613-7(o), there is no "transferee". However, under the proposed regulations, a distribution fraL the trust at the grantor's death is not specifically covered by the transfer at death exception. We Llzmuuend that the second sentence of the proposed regulation be amended to provide:

*However, the term does not include a transfer of property
at death-(including a distribution by an estate or by a.
trust which was fully revocable at death) nor an exchange
to which section 351 allies (until the tentative quantity
detenmined under the table contained in section 613(c) (3) (ii)
ceases to be allocated under section 613A(c) (8) between the
transferor and transferee)." (underscored words added)

Change in Beneficiaries

7e first sentence of proposed 51. 613A-7(n) also refers


Ctmmssioner of Internal Pevenue

to "any change in *** equitable ownership by *** a change in the beneficiaries of a trust". These words ny be interpreted to result in a "transfer" when any event (other than perhaps death) causes a change in the trust beneficiaries. For example, ccrsider a trust
which directs that ince be paid to A for 10 years and thereafter to B for his life with the principal to be distributed to B's issue wxo survive him, per stirpes. Does a "transfer" take place at the expiration of the 10 year period when A ceases to be a beneficiary? Does a "transfer" take place upon the birth of a child of B during the trust tenn? These questions should be answered in the negative. Our difficulties with the proposed language could be ovrcne by eliminating the words "or the beneficiaries of a trust" in the first sentence of proposed 51.613A-7 (n). We believe consideraticn should also be given to eliminating the words "legal or equitable" in this sentence which tend to create uncertainty in application.

Transfer at Death

The December 31, 1974 transfer rule does not apply to a
"transfer at death". The proposed definition of "transfer" does not give a clear explanation as to the scope of this exception. 7b iustrate, in the exaple discussed in the preceding paragraph the trust terninates at the death of B and the trust pr erty is distributed to B's then living issue, M stiffs. Is the transfer at death exception applicable? The regultions should answer this question, which is inportant because the death of a beneficiary is the most frequent event causing a trust to terminate.

Acquisition by Estate

In same cases an estate will acquire after the decedent's death oil and gas properes which turn out to be producing and then distribute the properties to the beneficiaries, which may include one or more trusts. This case differs fra the case where such a property is owned by the decedent at death. The transfer at death exception clearly applies to the latter case, but arguably does not apply to property acquired after death. Nevertheless, since the beneficial interests in the estate take effect at death, there should be no "transfer" of ary such interest when distributions are made. ne way or another, the regulations should provide that property acquired by an estate after a decedent' s death is not deemed to be transferred for purposes of section 613A when distributed by the estate.


Commissioner of Intenal Revenue

Pre-FEcIsting Trusts

In* intent of the December 31, 1974 transfer rule is to
prevent the intentional creation of multiple "small prlucers" by post1974 transfers. See Staterent of Senator Cranston on page S4260 of the Congressional Recod of March 18, 1975. This cmnot occur with respect to oil and gas property held in an irrevocable trust on Decbr 31, 1974 where the distribution frm the trust to a beneficiary occurs as a result of a mandatory provision rather than the exercise of a discretionary power. The application of the Dcember 31, 1974 transfer rule to a mandatory distribution would be unfair and ammt to retroactive legislation. We suggest the addition of the following new sentence to the proposed regulations Sl. 613A-7 (n):

"A distribution from a trust which was irrevocable on Decer
31, 1974 of property held in the trust an such date shall be dee-d a 'transfer' only if made pursuant to the exercise of
a discretionary power."

In the normal property law context the "transfer" takes place when the trust is created.

Jeectfuzlly sunitted,

Pdevt L. Bevan
Associate Federal LgsaieCounsel L2 "'C...... .. .

Richard B. Covey
Special Counsel






July 22, 1976


Background . . . . . . . . . 1

Ambiguities in the 1975 legislation . . . 4 Section 1317(a) Retailer Exclusion . . . 5

Exclusion of bulk sales from the definition
of retail sales w *.. 5

Limitation of prohibited retail activities
to those having combined gross receipts
exceeding $5,000,000 . . . . . 8 Section 1317(b) The Transfer Rule . . . 12 Computation of the 65% limitation in the case of
trusts 0 0 . . * 0 0 18

Section 1317(c) Partnership rules under section
613A of the Tax Reduction Act of 1975 . 21




July 22, 1976

The Tax Reduction Act of 1975 repealed the percentage depletion deduction for oil and gas. One exception retained the deduction for a limited quantity of domestic production under a "small producer exemption." The small producer exemption provisions, contained in new section 613A of the Internal Revenue Code, were adopted by Senate floor amendment and thus did not receive the careful attention usually afforded Internal Revenue Code provisions through the committee process. As a result many technical defects and inequities have been found in this new section. This Committee's adoption of section 1317 of H.R. 10612 corrects the most glaring errors of section 613A.

The attached statement makes the following points:

1. Bulk sales of oil and gas. -- The exclusion of bulk sales to industrial and commercial users from the term retail sales implements the intent of Congress in adopting section 613A(c), gives effect to the common usage of the term retail sales, and will prevent inefficient realignment of direct producer-industrial consumer sales.


2. Retail sales in excess of $5,9000,000. -- The limitation of prohibited retail activities to those exceeding $5,000,000 in gross receipts is consistent with the Congressional purpose of adopting the small producer exemption and will resolve ambiguous factual situations which would otherwise invite needless controversy and litigation.

3. Transfers of interests in trusts. Exempting certain transfers of beneficial interests in trusts from the possible loss of the small producer exemption is clearly necessary and desirable. It is submitted, however., that a more general exemption from the transfer rule of section 613A(e)(9) is necessary to remove the arbitrary and inequitable results which flow rrom the strait-jacket approach of the present provision (a suggested statutory draft is attached as Exhibit B).

4. 65% limitation in the case of trusts. -- Applying the 65% of taxable income limitation to trusts before the deduction ror distributions to beneficiaries is necessary to make the statutory scheme for taxation of trusts and their beneficiaries work correctly. This amendment should be broadened to cover estates as well.

5. Partnership basis rules. -- It is necessary to correct technical deficiencies relating to the computation of depletion &nd basis with respect to oil and gas properties in the case of I partnership and its partners.

88 1

July 22, 1976

My name is John E. Chapoton. I am an attorney in Houston, Texas. I am appearing on behalf of the Domestic Wildcatters Association, an association composed of more than 30 independent explorers and producers of oil and natural gas in Texas and Louisiana.

I am here today to testify with respect to certain provisions in section 1317 of H.R. 10612, the Tax Reform Bill of 1976, as reported to the Senate by this Committee on June 10, 1976. Section 1317 of H.R. 10612 makes certain changes, mostly technical, in section 613A of the Internal Revenue Code ("Code"), which was enacted by the Congress as a part of the Tax Reduction Act of 1975 enacted in March 1975. Background

By the enactment of section 613A of the Code the Tax

Reduction Act of 1975 repealed the percentage depletion deduction for oil and gas effective January 1. 1975. It did not, however, affect the percentage depletion deduction allowed all other minerals under the Code. Two exceptions were provided


in section 613A. One permits the continuance of the percentage depletion deduction at the old 22% rate and under the pre-1975 rules for (i) natural gas sold under a fixed contract in effect on February 1. 1975, and (ii) natural gas produced and sold before July 1, 1976, while subject to federal price regulation. This natural gas exemption is not the subject of my testimony today.

The second exemption, referred to generally as the

"small producer.exemption.," retains the percentage depletion deduction on a limited amount of domestic oil and gas production at a diminishing depletion rate. The maximum amount of production eligible for percentage depletion under the small producer exemption is 2,000 barrels average daily production of crude oil or its Btu equivalent in cubic feet of gas (established at a 1:6000 ratio in the legislation), for 1975 and phases down to 1,000 barrels of oil per day or 6 million cubic feet of gas per day for 1980 and thereafter. The percentage depletion rate for production which is eligible under the small producer exemption is retained at 22% through 1980 and then is phased down to a permanent rate of 15% for 1984 and later years. Production resulting from secondary and tertiary processes is treated. differently under the legislation



only by retaining the 22% rate through 1983 (however, the total amount of production eligible for depletion under the small producer exemption is not increased). In 1984 and. later years secondary and tertiary production is subject to the same 15% rate as primary production.

The percentage depletion deduction allowed a taxpayer under the small producer exemption is subject to a ceiling equal to 65% of the taxpayer's taxable income for the year, computed without regard to the depletion deduction taken under the small producer exemption and without regard to any net operating loss or capital loss carrybacks to the. taxable year.

In addition, no depletion deduction is allowed a taxpayer., even though he may otherwise qualify, with respect to production from his interest in an oil or gas property if his interest in the property was transferred after 1974 and the property was "proven" at the time of the transfer.

Finally, a taxpayer is not allowed any depletion deduction under the small producer exemption during any period for which such taxpayer or a related person is classified as a retailer of oil or gas, or any product derived therefrom, or engages in the refining of crude oil (if the refinery runs



of the taxpayer and such related person exceed 50,000 barrels on any day during the taxable year). Ambiguities in the 1975 legislation.

The computation of percentage depletion under the small producer exemption introduced many new rules and concepts into the computation of percentage depletion for oil and gas. In many instances the new rules are simply not set forth in sufficient detail in new section 613A of the Code. In other instances, new and imprecise terms., such as "retail outlet.." the meaning of a "related person" in this context,, and the definition of a "proven property," are utilized in the legislation. Many of these problems could have been solved by the prompt promulgation of reasonable interpretative regulations by the Treasury Department. However, this administrative clarification has not been forthcoming. The Treasury Department published very abbreviated proposed regulations on October 17, 1975, and although a hearing was held on the proposed regulations in January 1976, no final regulations have been issued to date.

What is worse., the abbreviated proposed rules evidenced an inclination on the part of the administrator to follow the cold statutory language to totally illogical results, clearly



inconsistent in many instances with'the purposes of the small producer exemption as indicated by its legislative history, This was particularly evident in the provisions of the proposed regulations defining a retailer. The proposed regulations would have found a "retail outlet" to exist., for example, by reason of direct bulk sales of natural gas from the wellhead to an industrial consumer. As another example an independent producer could be denied a percentage depletion deduction in toto by reason of relatively small retail sales of oil products resulting from a business activity totally unrelated to the taxpayer's oil or gas production business. Although theTreasury Department indicated informally some inclination to temper the most absurd results flowing from its proposed rules,, it has failed to do so in the nine months which have elapsed since the publication of the proposed regulations.

Section 1317 of H.R. 10612 handles many of these problems in a logical manner, giving effect to the obvious intent of Congress in adopting the small producer exemption. Section 1317(a) -- Retailer Exclusion.

Exclusion of bulk sales from the definition of retail


As discussed earlier, the small producer exemption is



denied if the taxpayer, directly or through a related person, operates a retail outlet which sells oil or natural gas or any product derived therefrom. In the Treasury Department's regulations proposed under section 613A. bulk sales of oil or natural gas, or products derived therefrom., would be considered retail sales if made to an end-user of the item. For example, a direct sale of natural gas by a producer from the wellhead to an electric utility for use as fuel for its furnaces would constitute a retail sale. The proposed regulations went on to provide that if such retail sales constituted more than 5% of the gross receipts from the "place" where such sales are madel then such place constitutes a retail outlet operated by the producer, resulting in the loss of percentage depletion on all of that producer's oil and gas production, wherever located and to whomever sold. The proposed regulations added a perplexing rule that bulk sales to industrial or commercial users would be disregarded in making this 5% computation if such sales accounted for less than 25% of the taxpayer's gross receipts derived from all sales of oil or natural gas, or products derived therefrom, during the taxable year. The purpose or logic of this 25% rule, which could cause the existence of the "retail outlet" to be dependent on the


74-659 0 76 7


taxpayer's total production from*other fields, was never adequately explained.

The proposed regulation definition of retail outlet was clearly inconsistent with the common usage of that term and would most assuredly impede the Congressional intent of making the small producer exemption available to normal independent producers who operate no service stations for the retail distribution of their production. Moreover, because of the devastating impact of classification as a retailer, (causing the loss of the entire percentage depletion deduction on all of the producer's domestic oil and gas income), such a nonsensical rule would result in wholesale realignment of sales arrangements to avoid direct sales to industrial and commercial users. The result would be the economically unnecessary insertion of a middleman with somewhat higher costs to the industrial consumer and eventually higher costs to the customers who use its product. Moreover, the proposed Treasury rule would frustrate the policy of the Federal Power Commission, adopted in its Order No. 553 dated August 28, 1975, to encourage direct interstate sales of natural gas to industrial consumers.

This Committee's amendment would correct this situation

by providing that bulk sales of oil and natural gas and products