Any remaining significance of the debt to equity ratio test is further diminished by the fact that differences in accounting methods, with respect to matters such as depreciation and the write-off of research and development costs will result in two companies of equal strength faring differently under the test. Many companies will suffer from the fact that their assets were rapidly written off for tax accounting purposes. Thus, it is obvious that tax cost as a measure of debt/equity ratio is wrong as a matter of law and reason. To use value, however, opens Pandora's box. Therefore, it is apparant that this test should be jettisoned. The projected earnings coverage test like the debt/ equity ratio test is also contrary to the approach set forth in numerous court decisions. Section 411 would look at the past and freeze the characterization of debt on that basis. The courts, however, have looked at earnings during the period the debt is outstanding. It certainly would be illogical to penalize a transaction which leads to revitalization of an ailing company by a denial of interest deductions on account of past poor performance. In addition, the earnings coverage test measures average historical earnings against "interest to be paid or incurred on total outstanding indebtedness". You are all familiar with what is colloquially referred to as "off-balance sheet financing", i.e., the use of long-term lease commitments as a financing alternative to the purchase of necessary assets with borrowed funds. A company which pays substantial lease rentals (which are the economic equivalent of debt service) would not take into account disguised interest costs in determining coverage under Section 411, whereas a taxpayer whose management chose direct financing would be required to include interest on such debt for that purpose. Again, taxpayers otherwise equal in financial ability would be treated differently under Section 411 as a result of management decisions and business considerations wholly unrelated to the merger in question. Furthermore, we would be faced again with the uneven treatment of otherwise similarly situated taxpayers who have adopted different methods of accounting for depreciation, inventory and various other items, and thus show widely differing earnings. Complexity Over the past five years I have lectured to Section thousands of accountants seeking to improve their command of the already complex Internal Revenue Code. My experience has demonstrated that it is difficult for the practitioner to grasp and retain the myriad of fundamentals contained therein. 411, directed at one non-tax problem, comprises eight pages of the House Bill. This type of additional complexity should be avoided at all cost when there is a far better alternative, as in this case. Such complexity can only lead inevitably to a breakdown in compliance and administration. Conclusion The task of controlling conglomerage mergers is within the province of the antitrust and securities law. It is not one which should be engrafted into the Internal Revence Code and enforced by revenue agents. The tests incorporated in Section 411 are incorrect, and unrealistic and will operate unfairly as between similarly situated taxpayers. Accordingly, we respectfully submit that the proposed Section be dropped. We thank the Committee for the opportunity of making this statement. Statement of T.F. Dixon Wainwright Attorney-at-Law 1710 Locust Street Philadelphia, Pa. 19103 September 29, 1969 To the Senate Finance Committee: Re: H.R. 13270, Sec. 412 (c) Effective Date of Amendments Regarding Summary The amendments apply to sales or other dispositions occurring after May 27, 1969. In some instances this effective date will result in inequity and hardship to taxpayers who prior to May 28, 1969 in reliance upon the present law have executed contracts of sale which were binding upon them. The amendments should not apply in cases where such contracts were entered into before the effective date. Discussion Sec. 412 of H.R. 13270 would amend Sec. 453 (b) of the Internal Revenue Code (relating to sales of realty and casual sales of personalty) by providing in effect (1) that an installment transaction is one in which the payment of the principal is spread relatively evenly over the installment period and (2) that certain evidences of indebtedness of a corporation shall not be treated as evidences of indebtedness of a purchaser. As to whether or not the effects sought to be accomplished by these amendments are desirable or not I have no comment. What would produce improper and inequitable results if it becomes law is Sec. 412 (c) of the Bill which reads: "EFFECTIVE DATE The amendments made by this section shall apply to sales or other disposi- There should be an exception for transactions where the contract or agreement of sale had been executed prior to May 28, 1969. A seller should surely be entitled to rely on the law as to the installment method as it existed at the time that he bound himself by a contract of sale. It is unfair for the law retroactively to change the tax effect of such a transaction. When a seller has bound himself by a contract prior to May 28, 1969, he cannot change its terms merely because the law changed afterwards. If at the time that he entered into the contract he had had any possible way of knowing that the provisions of H.R. 13270 might become law, he would have demanded a larger down payment from the buyer so that at the least he would have had funds in hand to pay the tax liability, which under the terms of this Bill would now all be bunched in the year of sale. A typical situation affected by the amendments is a sale of real estate by an individual to a developer who makes a down payment at the time of the sale and gives a purchase money mortgage to secure payment of the balance of the consideration. Normally in such cases it is provided that the principal of the debt will become due in a relatively short period of time, say five or six years. Although there is no schedule for fixed part payments of principal prior to the due date, the mortgagor must pay part of the principal indebtedness from time to time in order to release portions of the land from the lien of the mortgage as the development proceeds. In such a case a landowner who contracted to sell in the proper belief that he had the right to report his gain on the installment method will suffer great financial hardship if the amendments retroactively take that right away from him. As a tax practitioner I advise my clients to the best of my ability as to the tax consequences of various transactions that they wish to enter into. In order to do so I study the Internal Revenue Code, the Regulations, the cases and commentaries on the law. If I must also take into consideration possible future legislation retroactively -2 |