taxpayer replaces a leaky roof or installs an elevator, or air-condi tioning equipment in rental property, he loses his right to claim that the property is held for investment. The same result follows if he is holding undeveloped land for investment and he clears, levels, or drains it. (5) The holding period is extended from the 6 months applicable to other types of property, to 5 years, a tenfold increase. (6) Even if the taxpayer meets all the restrictive qualification of section 1237 he gets only a part of the relief to which he is entitled. Under existing law on the sale of an investment all gain is taxable under the capital-gains provision, under section 1237, 5 percent of the sales price, less selling expense, if any, is automatically taxed by this bill as ordinary income. (7) The section will result in a windfall for the 1 taxpayer who is clearly not entitled to relief, a dealer who has carried property for 5 years as stock in trade without making any improvements. He may now make a designation on his books, which is clearly contrary to the facts that is, investment property-and convert ordinary income into capital gain. For these reasons we urge: (1) That the holding period be reduced from 5 years to 6 months as is the case with other capital assets. (2) If, however, the committee cannot agree to this proposal we suggest that section 1237 be deleted from the bill and the whole subject matter be given further study. (3) Should the committee insist that legislation on this subject be included in the bill, we strongly urge that section 1237 be amended, at the very least, to make clear that the taxpayer who does not deliberately elect to subject himself to the burdensome conditions of this section will have his rights under existing law preserved. The form of amendments to accomplish this are attached to our written statement filed herein. Now, Mr. Chairman, I cannot overemphasize the importance of our contention that this section although designed to remove an inequity, actually aggravates the existing one. The Wall Street Journal on April 14 in its tax report column, in discussing this 1237 headlines it as follows: Capital Gains Rules for Real Estate Dealers Would Be Stiffer. You can imagine what repercussions that has had in our industry because originally the section was put in the bill to relieve an inequity and the House report states clearly that the real-estate dealer is getting something here that he doesn't have under existing law. The CHAIRMAN. Has the staff considered that? Mr. SMITH. We have gone into it with him. Mr. WILLIAMSON. We have had consultations with the staff. I would like to discuss 461 (c), regarding accrual of real-property taxes. This section changes the rule for the accrual of real-property taxes. Under present law real-property taxes accrue on the date of which such taxes become a lien under local law. Under section 461 (c) of the bill real-property taxes must be accrued ratably in each month of the year to which the tax applies. Although the future effects of this provision may be desirable as presently drafted it would produce a substantial distortion of taxable income for many real property owners in the transition year. To illustrate, in Pennsylvania, Virginia, Wisconsin, and numerous other States, real-property taxes for each year become a lien under local law on January 1 of such year. Under existing law, taxpayers accrue the full year's taxes on that date, regardless of their accounting period. Under section 461 (c) (2) in the transition year, fiscal year taxpayers may have been deprived of as much as eleven-twelfths of the deduction of real-property taxes to which they would normally be entitled. Thus, a Pennsylvania or Virginia taxpayer, on a January 31 fiscal year, beginning February 1, 1954, could deduct only 1 month's real-property taxes upon his return for the 12-month period ending January 31, 1955. Now, we recommend that section 461 (c) (2) be deleted from the bill since it would limit the deduction of taxes previously accrued. If this limitation is not deleted we urge most strongly that the provision be made elective rather than mandatory. Mr. Chairman, this came to our attention within the last week and I have not had the opportunity to consult with the staff, although I understand that other witnesses have discussed the difficulty raised by this particular section. Mr. SMITH. That is right. Mr. WILLIAMSON. Thank you very much, Mr. Chairman. We will meet at 10:30 in the morning. (By direction of the chairman, the following is made a part of the record:) STATEMENT ON H. R. 8300 BY THE LAKE SUPERIOR IRON ORE ASSOCIATION The Lake Superior Iron Ore Association represents most of the producers of iron ore from Minnesota, Michigan, and Wisconsin. These States normally produce about 80 percent of the iron ore consumed by the blast furnaces and steel plants of this country. The members of this association consider that the proposed revision of the Internal Revenue Code is a substantial improvement over the existing code. We have not had an opportunity to consider all phases of this entire bill, but have concentrated our attention on those provisions of particular interest to the iron-ore industry. Later experience with provisions of the bill may indicate the need for further change and there should be a willingness to make such changes when the need becomes evident. We urge that you consider the following amendments to certain provisions of H. R. 8300 which are confined to some of the problems of particular importance to the iron-ore mining industry. 1. DEFINITION OF PROPERTY Under section 614 (b) (1) provision is made for election to aggregate separate interests for purposes of computing percentage depletion. Such an election should be permitted both for purposes of percentage depletion and for purposes of cost depletion. The rule as stated permits but one aggregation within a single operating unit. It should be made clear that a separate right of election exists in respect to each operating unit. Also, it may be desirable to form more than one aggregate within a single operating unit and we urge that the taxpayer should be permitted to elect to form one or more aggregations of mineral interest within each operating unit. Section 614 (b) (2) relating to the manner of his election appears to subject the taxpayer to unreasonable restrictions. In the interest of simplified administration we believe that once the taxpayer has established his property aggregate by making an election, he should continue to recognize that aggregation so long as conditions which dictated the election remained unchanged. However, the taxpayer should be permitted a new election when changing circumstances demand a defferent aggregation. Among the changes which would permit a reconsideration of the properties included within a particular aggregate are the following: (a) Where additional properties are acquired or previously owned properties are disposed of which could reasonably affect the makeup of the aggregate. (b) Where properties which had not yet reached the production stage at the time of election were included in an aggregate but where, after reaching the production stage, additional fact become established which indicate that such property should not reasonably constitute part of such aggregate; or if not previously included in an aggregate that such property should be included in an aggregate. (c) Other material changes in the circumstances which might dictate a different aggregation of properties than was indicated at the time that the original election was made. If the taxpayer is permitted to make the same aggregation both for cost and percentage depletion purposes the provisions relating to allocation of depletion allowances included under section 614 (b) (4) and the last sentence of section 613 (a) appear to be superfluous. 2. PERCENTAGE DEPLETION OF WASTE PILES Section 613 (c) (3) and section 381 (c) should be clarified to state the right of an acquiring corporation to take percentage depletion upon the extraction of ores or minerals from the waste or residue of prior mining in the case of a taxfree reorganization. Similar clarification is needed with respect to extension and renewal of leases where both the deposit of the waste or residue and the extraction do not occur within the period covered by one lease instrument. 3. DEPRECIATION We understand that it was the intent to allow mining companies the right to also use the methods of depreciation provided under section 167. We request that subsection (h) be revised to clearly state that mining companies will be allowed to determine depreciation under the methods provided in section 167 as well as those contained in section 611. 4. ADVANCE MINIMUM ROYALTIES No reference is made to H. R. 8300 to advance minimum royalties. Under regulation 118, section 39.23 (m)-10, the taxpayer is bound by an election in the first taxable year ending on or after December 31, 1939, in which such amounts are paid or accrued as to the treatment of minimum royalties in subsequent years. National security demands sufficient reserves of iron ore to insure an adequate supply of raw materials. If we are to maintain full capacity steel production in the event of emergency, this requires the maintenance of large reserves of iron ore which in turn means material increases in the payment of advance mineral royalties. The taxpayer therefor should be permitted an election with respect to advance minimum royalties which will permit the taxpayer to deduct such costs for any mineral property in the year paid or accrued or to defer the deduction to the year in which the mineral product in respect to which the advanced royalties were paid is sold. We recommend that a taxpayer be permitted to make a new election with respect to advance minimum royalties for each mineral property in which he owns interest during the taxable year 1954. For properties acquired after January 1, 1954, election should be made in the tax return filed for the year of acquisition. 5. EXPLORATION EXPENDITURES We have recommended in the past and feel strongly that both the present revenue law and H. R. 8300 do not give adequate recognition to the cost of present day exploration. Most easily discovered mineral deposits-especially those of iron ore-have been found and from now on the expenses of exploration will greatly exceed those of the past. If the necessary reserves of iron ore are to be maintained, exploration must be encouraged. Section 615 allows as a deduction only $75,000 a year for 4 years for each taxpayer. This amount does not begin to cover cost of iron-ore explorations for deep underground mines or large deposits of low-grade iron ore. Previous statements before the Ways and Means Committee have emphasized the importance of encouraging iron-ore exploration and we feel that the maintenance of adequate iron-ore reserves has enough national significance that we should bring the matter to your attention. We therefore urge the removal of the $75,000 annual and the 4-year limitation, in order to permit expenditures incurred in prospecting to be deducted as an expense either in the year incurred or at the taxpayer's election, deferred and written off against resulting ore, or deducted when there is no reasonable expectation of resulting production. Respectfully submitted. FRANKLIN G. PARDEE, President. APRIL 19, 1954. Re H. R. 8300 To the Chairman and Members of the Committee on Finance, GENTLEMEN: The undersigned respectfully submit herewith our views on the tax on corporations improperly accumulating surplus, and ask that this statement be included in the record of hearings by your committee. Sections 531 to 536 of H. R. 8300 levy a tax on corporations improperly accumulating surplus. There sections correspond to section 102 of existing law. The tax is a penalty tax levied upon all the undistributed earnings for a taxable year if the corporation was formed or availed of to avoid income tax on its shareholders by permitting earnings and profits to accumulate instead of being paid out in dividends. Several amendments are incorporated in the new bill in order to minimize the inherent threat of this tax where funds are accumulated for legitimate business purposes, to exempt publicly held companies and small corporations. The amendments are generally helpful, but they do not remove all of the inequities of section 102. Publicly held corporations The bill exempts a publicly held corporation from this tax. A publicly held corporation is defined as one whose outstanding stock is held by more than 1,500 persons with not more than 10 percent of the total voting power or total value of all outstanding stock owned by any one individual. For the purpose of the 10-percent test, stock owned by an individual's relatives, partners, etc., will be attributed to the individual. In order to obtain the exemption, proof must be submitted in accordance with regulations to be issued. The purpose of this provision is to exempt corporations which could not be used by a limited group to avoid tax by nonpayment of dividends. It seems doubtful, however, whether many widely held companies will be able to obtain the necessary information to satisfy the 10-percent test. If a corporation's shares are traded in actively, there may be a large number registered in the names of brokers. Similarly, many shares are held in custody accounts by banks and brokerage houses and registered in the name of the custodian. As a general rule the custodian will not disclose the name of the owner in such cases. Accordingly, a corporation whose shares are widely held may be unable to prove the identity of the owners of more than 10 percent of its stock. Since it is the directors who determine a corporation's dividend policy, there would seem to be adequate protection if the 10-percent test were applied only to directors. A corporation can obtain the facts from its directors as to their stock ownership. If further protection is needed to prevent the use of dummy directors by a closely held company, it is suggested that 25 percent ownership by stockholders other than directors would be an adequate test. All undistributed earnings are taxed The penalty nature of the tax is emphasized by its imposition on an all-ornothing basis. A corporation must show that every dollar of undistributed earnings was accumulated for a legitimate business purpose. If it fails, the entire amount is subject to the tax, even though the major portion may not be subject to any question. As a result the tax may equal a penalty of nearly 100 percent of the part of the accumulated earnings found to be unreasonable. It would seem more equitable to allow a deduction for that part of the accumulation found to be necessary for business reasons. Burden of proof The bill shifts the burden of proof to the Secretary or his delegate if the taxpayer has filed a statement of the grounds (together with facts sufficient to apprise the Secretary of the basis thereof) on which the taxpayer relies to show that earnings were not accumulated beyond the reasonable needs of the business. The burden of proof is shifted only with respect to the grounds set forth in the statement. This is an entirely proper procedural change in the case of a penalty tax. The burden of proof has been on the Government in cases where a fraud penalty is asserted ever since the Revenue Act of 1928. Burden of proof-effective date The bill provides that the new rule shall apply only to cases involving taxable years beginning after December 31, 1953, where a notice of deficiency is mailed more than 90 days after the date of enactment of the title. This is an unwarranted restriction since the change affects only procedure, not substantive law. Perpetuating the existing rule in cases involving prior years, whether now pending or initiated in the future, may produce results which the Ways and Means Committee found undesirable in several instances. The new rule should be made effective in every case where no trial before the Tax Court has been held before enactment of the bill. There is precedent for such treatment in the effective date provided by the Revenue Act of 1928 for shifting the burden of proof in fraud cases to the Commissioner (Revenue Act of 1928, sec. 601, amending sec. 907 (a) of the Revenue Act of 1924). Prior to the enactment of the Revenue Act of 1928, the burden of proof in all cases before the Board of Tax Appeals (except in respect of new matter pleaded by the Commissioner) was upon the taxpayer. (See Louis Ginsburg, 13 B. T. A. 417.) The 1928 act changed this rule by providing: "In any proceeding involving the issue whether the petitioner has been guilty of fraud with intent to evade tax, where no hearing has been held before the enactment of the Revenue Act of 1928, the burden of proof in respect of such issue shall be upon the Commissioner." [Emphasis supplied.] Your committee stated: "This change will affect proceedings in which hearings are held (by the Board of Tax Appeals) after the date of the enactment of the new act, even though the petition was filed prior thereto." (Report of Senate Finance Committee (70th Cong., 1st sess., S. Rept. 960) p. 38.) The reasons given in the report of the Ways and Means Committee for shifting the burden of proof in cases involving the accumulated-earnings tax emphasize the desirability of applying the new procedure to pending cases. The committee found indications that deficiencies have been asserted in many cases which were not adequately screened or analyzed. Taxpayers have been put to substantial expense and effort in proving their cases. Complaints by taxpayers that this tax is used as a threat by revenue agents to induce settlements on other issues appear to have a connection with the imposition of the burden of proof on the taxpayer. Finally, the report stated: "It also appears probable that many small taxpayers may have yielded to a proposed deficiency because of the expense and difficulty of litigating their case under the present rules" (p. 52). Many cases may be pending in which imposition of the burden of proof on the taxpayer will produce such results. Despite the best efforts of the Commissioner, new cases will probably arise for years prior to 1954 in which taxpayers are penalized because of this procedural handicap. It seems indefensible to refuse this relief in pending cases, unless it would create administrative problems. It is worthy of note, however, that no such problems prevented immediate application of the same procedural change in 1928 as to fraud cases. No administrative problems should be encountered by shifting the burden of proof in cases heard by the Tax Court after the bill is enacted. In cases where no deficiency notice has been issued, the Commissioner would merely be required to follow the new procedure. If a deficiency notice has already been issued, the taxpayer could be permitted to include the statement referred to in section 534 (c) of the bill in its original petition to the Tax Court, or by amendment thereto if the original petition has already been filed. If the case has been adequately considered before the deficiency notice was issued, the Government should already have sufficient facts to assume the burden of proof, or have no difficulty in obtaining the necessary additional information from the taxpayer's statement. |