C. UNDER SWITCH FROM ACCRUAL TO INSTALLMENT METHOD AT END OF 1954 HOUSE BILL (Same in every respect as B; no benefit whatever obtained.) D. UNDER SWITCH FROM ACCRUAL TO INSTALLMENT METHOD AT END OF 1954, PROPOSAL ADVANCED HEREIN MEMORANDUM OF PROPOSED AMENDMENT OF SECTION 851 (a) of H. R. 8300, REGULATED INVESTMENT COMPANIES I. Introduction Provisions of both the present Internal Revenue Code and H. R. 8300 deny to personal holding companies the right to qualify as regulated investment companies with the advantages that follow from such qualification. There is no apparent historical or logical reason for this discrimination against personal holding companies. Investment counselors and other investment concerns, which rightfully should be treated as true investment companies, are compelled thereby to operate in a cumbersome, expensive fashion, which impedes and discourages trading and diversification, solely because of the representation among their stockholders of family client-groups. We believe this discrimination should be eliminated. From a drafting standpoint, the amendment can be accomplished by a very simple change as set out below. II. Statement of proposed amendment Section 851 (a) (subch. M) of H. R. 8300 should be amended to permit a personal holding company (as defined in sec. 542 of H. R. 8300) to qualify as a regulated investment company. This amendment would be accomplished by deleting from the third line of section 851 (a) the parenthetical phrase "(other than a personal holding company as defined in sec. 542)." III. Legislative history of pertinent regulated investment company provisions The parenthetical phrase referred to above appears in the provisions of section 361 (a) of the present Internal Revenue Code. It has appeared in this provision of the present code since its enactment in 1939 and appeared in the Revenue Acts of 1936 and 1938. There is no indication in the legislative history as to why an exception was made excluding personal holding companies from the benefits of the regulated investment company provisions. On the contrary, it would appear that the reasons which prompted the enactment of the provisions covering regulated investment companies, apply as well in the case of closely held groups as in the case of larger organizations. Prior to the enactment of these provisions, socalled investment companies were treated as trusts, when organized as pure conduits. Some fear developed, however, that they might be taxed as corporations because of the features of centralized management, transferable interests, etc. It was primarily to eliminate this possibility that these provisions were first enacted to insure treatment of these investment companies as mere conduits. (See statement of John Sherman Myers, Hearings Before Senate Finance Committee on the Revenue Act of 1936, p. 776.) This basis for enacting these provisions contains no grounds on which a distinction can be made between closely held and more widely held companies. It may be presumed that the draftsmen had in mind that the benefits of the regulated investment company provisions should only be available to companies which are more than mere "incorporated pocketbooks." But, if this is the case, the assurance that regulated investment companies would have some public character is amply provided by the requirement of the code that they be "at all times during the taxable years * ** registered under the Investment Company Act of 1940 * *" as discussed more fully below. * It appears, therefore, to be clear that there is no reason apparent in the legislative history why this exception for personal holding companies should not be deleted from the code. It further appears from the legislative history that the underlying reasons for the enactment of the regulated investment company provisions apply as well to companies in the category of personal holding companies as to those which are more widely held. IV. Provisions of the present Internal Revenue Code and H. R. 8300 deny the benefits of treatment as a regulated investment company to many investment counselors and other investment concerns because of the representation among their stockholders of family client groups. The operations of these concerns are thereby impeded and desirable diversification and freedom of trading is greatly hampered Firms acting as investment counselors or investment trusts have grown in many instances from handling the investments of family client groups and have gradually added clients independent from such family groups until their clientele represents a substantial, diversified aggregation. In many cases, however, more than 50 percent of the investments involved continue to be held or managed for no more than 5 family client groups thus bringing the entire operation within the ambit of the personal holding company provisions if the corporate form is adopted. Because of this situation, it has not been feasible to employ the corporate form, even though all income is distributed currently, because of the applicability of corporate taxes. As a consequence, these firms have been required to establish separate accounts for each client with individual investments held for each account. The burden of administrative detail is not only expensive and onerous, but, in addition, it has very substantially hampered diversification and has made trading cumbersome and uncertain. The present situation thus operates to restrict these two objectives which have been commonly regarded as desirable. These problems are eliminated for qualifying companies by the regulated investment company provisions which permit all investments to be held in a common fund with certificates of interest issued against the fund as a whole. Substantially the same advantages are accorded to banks under the provisions permitting the existence of common trust funds. We believe that the type of investment firms referred to above should rightfully be treated in the same way as other investment trusts and should be accorded no lesser advantage than that given to banks. The character of their business and operations do not differ in any way from the usual investment trust; the problems to which the regulated investment company provisions would apply are the same in both instances. We submit that there are no factors with respect to personal holding companies of the type which could qualify as regulated investment companies (if the law were changed as here suggested) on which the advantages of the regulated investment company provisions should be denied to these personal holding companies. We deal with this point in the section next below. V. The proposed change would not restrict the personal holding company provisions. On the contrary, these provisions would still apply and only a true investment type of personal holding company could, in fact, qualify as a regulated investment company We do not propose any change in the personal holding company provisions. They would continue to apply so that any failure to distribute earnings would result in a penalty tax and the other safeguards of the personal holding company provisions would remain applicable. Nor would the proposed change confer any benefit, on a wide basis, on personal holding companies of the pure holding company type. Such pure holding companies could not, in any event, meet the diversification requirements for qualification under the regulated investment company provisions. The only type of personal holding company which could qualify as a regulated investment company, if the proposed change were made, would be one which had diversified investments, which currently distributed at least 90 percent of its net income, and which derived its income at least 90 percent from stocks and bonds (through dividends, interest, or gains). It is precisely this type of investment firm, which so closely follows the usual investment firm pattern, which would be benefited from the change. All other personal holding companies would be unaffected by the change. There are, thus, no unfavorable consequences, in the personal holding company field, which can be perceived as a result of the proposed change. VI. The proposed change would, of course, leave unaffected the requirement that a regulated investment company be registered throughout the taxable year under the Investment Act of 1940, thereby assuring the protection of the interest of the public and of the shareholder in such companies In the event the change here proposed were made, a personal holding company would, in order to qualify as a regulated investment company, be required to be registered under the Investment Act of 1940, as amended. It would, thus, be required to have 100 or more stockholders, or to make its stock the subject of a public offering. This requirement, thus, would continue to provide the most logical means of protecting the interests of the public and of the shareholders in regulated investment companies. Personal holding companies, qualifying as regulated investment companies, would, thus, be forced to meet the requirements of annual reporting imposed by the Securities and Exchange Commission. It would also be made certain that such companies would have some public character, as assured by the requirement of at least 100 stockholders, or that they submit to the rigorous requirements of a stock registration under the Securities Acts of 1933 and 1934. Accordingly, the change proposed here could only result in subjecting personal holding companies, qualifying as regulated investment companies, to means of insuring the protection of the interests of the public and of the shareholders, beyond the devices employed in the personal holding company provisions. VII. Conclusions and recommendations A. Exclusion of personal holding companies from qualification as regulated investment companies has resulted in the denial to many true investment firms of the benefits of these provisions. An unwarranted discrimination is thus worked between such firms, on the one hand, and other investment concerns and banks (for whom special provisions are made) on the other. B. This discrimination hampers the operations of many investment firms and substantially impedes diversification and trading. C. Extension of the regulated investment company provisions to personal holding companies is a desirable and logical step to eliminate these disadvantages and discriminations and to accord to true investment firms the benefits of these provisions. D. This change would not disturb the present personal holding company provisions and would not affect in any way the true holding company which could not qualify as a regulated investment company in any event. E. The interests of the public and of the shareholders would be adequately protected by the requirement of registration under the Investment Act of 1940. Recommendation. It is respectfully recommended that section 851 (a) of H. R. 8300 be amended to delete the parenthetical phrase "(other than a personal holding company as defined in sec. 542)." NEW YORK, N. Y., April 22, 1954. GEORGE E. CLEARY. (Whereupon, at 1:20 p. m., the committee adjourned to reconvene at 10:30 a. m., Tuesday, April 20, 1954.) THE INTERNAL REVENUE CODE OF 1954 TUESDAY, APRIL 20, 1954 UNITED STATES SENATE, The committee met, pursuant to recess, in room 312, Senate Office Building, at 10:40 a. m., Senator Eugene D. Millikin (chairman) presiding. Present: Senators Millikin and Martin. The CHAIRMAN. The meeting will come to order, please. Mr. Ralph W. Button. Be seated and make yourself comfortable, Mr. Button, and identify yourself to the reporter. STATEMENT OF RALPH W. BUTTON, MEMBER, TAXATION AND FISCAL POLICY COMMITTEE, AMERICAN RETAIL FEDERATION Mr. BUTTON. I am Ralph W. Button, assistant secretary of Allied Stores Corp. I appear before you today as a member of the taxation and fiscal policy committee of the American Retail Federation. The American Retail Federation is a federation of 26 national retail trade associations and 34 statewide associations of retailers, representing in all more than 600,000 retail outlets. A list of participating member associations is attached to this statement. We have limited our oral testimony to sections 461 (c) relating to the accrual of real property taxes and sections 6016, 6154, and 6655 relating to the declaration of estimated income by corporations. We are concerned with other provisions of H. R. 8300 which we have set out in our more detailed brief accompanying this statement. There are approximately 25 States which specify January 1 as the date real property taxes become a liability. The period covered by this property tax is the calendar year. Taxpayers who file their income-tax returns for a fiscal year ending in 1955 will be permitted to deduct only a portion of their 1955 real-property taxes. Thus, retailers operating on a fiscal year ending January 31, 1955, will be allowed to deduct one-twelfth of their 1955 real-property taxes. This means that their taxable net income will be increased by eleventwelfths of the real property tax expense by reason of the special rules set out in section 461 (c) (2). I have applied this section to a specific retailer operating in Massachusetts. Under the present law, his tax liability is $42,900 or an effective rate of 46.1 percent. The disallowance of his real property tax expense in January 31, 1955, all other factors being equal, his tax liability will be increased to $69,500 or an effective tax rate of 74.6 percent on the same accounting net income. The disallowance thus costing him $26,000. The CHAIRMAN. Is that what the staff figures? Mr. SMITH. This problem has been brought to our attention and it is being studied. Mr. BUTTON. Does that mean The CHAIRMAN. He won't tell us what it means. He has indicated enough that it will make it clear to you that the subject is being carefully considered. That is not a guaranty that you are going to get anything. Mr. BUTTON. I would like to continue, sir, because I think there are other statistical figures which point up the problem. I have made the same calculation for six other retailers operating in other States and I will cut my comments short. The total increase in income taxes for these 6 retailers amounts to $785,200. So section 461 (c) is known as a sleeper, and now that I know you are considering it, I will continue. The result reached by the application of section 461 (c) to actual situations surely points up the need for careful consideration and study of all of the provisions of H. R. 8300. The declaration and estimation of income taxes by corporations present serious financial and administrative problems, particularly for retailers. The House committee report indicates that out of 425,000 corporations, 35,000 corporations have been singled out for this special tax treatment. These 35,000 corporations were selected for the stated reason that they account for 90 percent of the corporation income-tax liabilities. The House committee report does not indicate the kinds of companies in their 35,000 figure. What is the economic status, the financial status of these companies? Will the enactment of section 6016 and related sections create greater problems than the problems sought to be solved? These are some of the questions that need to be answered before these sections are enacted into law. The House committee report indicates that consideration has been given to only one part of the problem. In this connection, I call your attention to an article appearing in the New York World-Telegram and Sun-and a copy is attachedwhich shows that 25 corporations showed a net profit of $4.3 billion in 1953. A rough estimate of the corporation income-tax liability on this amount of income is $2.2 billion, which I estimate is approximately 10 percent of all corporation income taxes. If 11,400 of this group of 35,000 corporations accounts for onetenth of the corporate income tax liability, is it not possible that a relatively few corporations account for a major part of the total tax liability? If this is true, how many thousands of corporations with tax liabilities of just over $50,000 are classified into this group, and what is the impact of this section on them? We must measure the adequacy of the solution proposed by section 6016, and so forth, against a true statement of financial ability of all the 35,000 corporations mentioned. Retailers, particularly, will have difficulty meeting the financial and administrative requirements of section 6016 and related sections. The average retailer produces more than half of his annual profits, the range being 48 percent to 80 percent, during the months of October, |