individuals, trusts, Subchapter S Corporations, personal holding companies and noncorporate partners of partnerships.

The Revenue Act of 1978 extended the "at risk" provisions of section 465 to "closely-held" corporations. Such "closely-held" corporations were defined by reference to section 542(a)(2) of the Code to include those corporations where, at any time during the last half of the taxable year, more than 50 percent in value of the corporation's outstanding stock is owned, directly or indirectly, by for not more than five individuals.

However, the Revenue Act of 1978 excluded from the "at risk" rules those "closely-held" corporations which are actively engaged in leasing tangible personal property (or, as it is referred to in the Code, "Section 1245 Property"). In determining whether a "closely-held" corporation is actively engaged in leasing equipment which is section 1245 property, section 465(c)(3)(D)(ii)(II) now provides that "a closely-held corporation . . . shall not be considered to be actively engaged in leasing such equipment unless 50 percent or more of the gross receipts of the corporation for the taxable year are attributable to leasing the selling such equipment.' Section 465(c)(3)(D)(ii)(II) now provides that "in case of a controlled group of corporations (within the meaning of section 1563(a), this paragraph shall be applied by treating the controlled group as a single corporation."

The effect of this latter provision was to apply the “at risk” limitations to a number of substantial leasing operations because the gross receipts of some members of a controlled group of corporations could be substantial in the absolute sense, but would not constitute 50 percent of the aggregate gross receipts of all members of the controlled group. The proposed Technical Corrections Bill of 1979 now proposes to solve this problem by deleting all of section 465(c)(3)(D)(ii) and substituting, a new section 465(c)(5).

This proposed new section would waive the controlled group rule and allow an alternative test for determining, on a separate corporation basis, whether such separate corporation member of a controlled group is engaged in substantial leasing activity. As proposed, in order to avail itself of the separate corporation test, the gross receipts of such corporation from leasing activities must be 80 percent of the gross receipts of such corporation. In addition, proposed section 465(c)(5)(B) provides that three additional tests must be met by such corporation for the taxable year and each of the two immediately preceding taxable years of such corporation. These three tests are (1) the group, for each of such three years, must have at least 3 fulltime employees substantially all of whose services where directly related to the equipment leasing activity; (2) during each of such three years, the leasing members of the group must have entered into at least five separate equipment leasing transactions and (3) during each of such three years, the leasing members of the group must have had, in the aggregate, at least $1,000,000 in gross receipts from equipment leasing. By requiring equipment leasing corporations to meet these tests in not only the taxable year, but also for the two immediately preceding taxable years, the proposed amendments from being preclude a controlled group of corporations from being excluded from the "at risk" provisions with respect to newly formed equipment leasing members of the group for a minimum of three years. Speaking to this narrow provision only, such a result could be eliminated by addition of a parenthetical clause in proposed section 465(c)(5)(B) which would read somewhat as follow: "or for such part of such period immediately preceding such taxable year as may be applicable.'

However, the most troublesome requirement in the proposed legislation is the requirement that the aggregate gross receipts from equipment leasing in the taxable year, and in whatever applicable preceding period, must be at least $1,000,000. This would preclude the exemption from the "at risk" rules for a corporation which is a member of a controlled group, the activities of which are solely equipment leasing, but are not of a sufficient magnitude to meet presently proposed high dollar requirement of a leasing volume of $1,000,000 in gross receipts. We would recommend that such absolute dollar limit be eliminated. The effect of this proposal would be to allow a corporation that is member of a controlled group the exemption from the "at risk" rules, provided that such corporation's gross receipts from leasing are 80 percent or more of the total gross receipts such corporation.

The elimination of an absolute $1,000,000 requirement would accomplish two objectives: (1) it would not penalize those controlled groups of corporations which have a leasing member in a "start-up" position and (2) would stimulate the economy by encouraging smaller businesses to purchase and lease new equipment.

We do not believe the elimination of the flat $1,000,000 requirement will lead to abuses because our proposals still leaves intact the "80 percent of gross receipts" test, the "three employee" test and the "five separate lease transactions" test. Since

substantial capital would have to be invested by a corporation in equipment to be leased to meet these tests, it would, we believe, preclude the creation of a corporation solely for the purpose of tax avoidance.

Many of our WAEL members could be at a disadvantage by the present wording of this act, either because they cannot meet the three year requirement or the one million dollars in gross leasing receipts.

Depending on how the present wording is interpreted, it could have a significant adverse impact on many small leasing firms as well as that segment of the business community which these people serve. More than one-third of our membership has been in business less than three years, and a far greater percentage would not currently meet this $1,000,000 gross receipts criteria.

It is anticipated that the leasing industry will continue to experience exciting and dramatic growth over the next five and ten years. As the ravages of inflation continues to impact the business community, leasing has and will continue to be a much better understood and much more used vehicle to finance the capital growth which most business and our entire economy must achieve.

Perhaps, 60% to 70% of today's leasing business is being done by what might be called the large leasing companies and banks. That's significant, however, the independent leasing segment, is still an important part of the market mix and will continue to be as the total market accelerates and expands.

The large banks and corporate lessors, may dominate the market, but they can never serve it all. There are, as in every industry a different degree of service and flexibility as well as personal rapport that the small businessman can offer, that our larger colleagues cannot.

We have our total net worth on the barrel head, right on the line everyday competing with these corporate giants. We don't want an advantage, we just want to be able to compete on an equal basis. The small businessman supports equality in taxes for large or small.

In summary, the members of our organization feel there is at very least some ambiguity in the wording of Section 5. Our proposals to amend that wording and eliminate the $1,000,000 gross leasing receipts requirement would clear up the ambiguity, without, we believe damaging the intent of the proposed section-and it will accomplish that purpose without impairing the ability of the small businessman to function or impair his ability to serve the business community.

Senator BYRD. The next panel consists of Ernest S. Christian, Jr.; Albert G. Doumar, and Patrick A. Naughton, Committee of Banking Institutions on Taxation; and Matthew Newman, international pension consultants.

Welcome, gentlemen. Proceed as you wish.

STATEMENT OF ERNEST S. CHRISTIAN, JR.

Mr. CHRISTIAN. Mr. Chairman, I would ask that my written statement be made part of the record.

Senator BYRD. Without objection, so ordered.

Mr. CHRISTIAN. The subject of my testimony, Mr. Chairman, is section 701(u)(2)(C) of the 1978 act which deals with the question of the character to be given to gain realized from the sale of stock outside the United States, most particularly the sale of stock by one corporation of stock in another corporation.

Senator BYRD. Now is this a technical correction?

Mr. CHRISTIAN. Yes, sir, I believe it is. In fact, it is a technical correction to the technical correction portion of the 1978 act. As you know, title VII of the 1978 act was in fact the Technical Corrections Act of 1978 dealing with the 1976 act.

Senator BYRD. Well, does your proposal deal with 1976 or 1978? Mr. CHRISTIAN. The proposal here is to make a correction to the technical correction made in 1978 to the 1976 act.

The background, Mr. Chairman, is that in the 1976 act, section 904(b)(3) was amended to provide substantial restrictions on the extent to which income from the sale by one corporation of stock in

another corporation outside the United States would be treated as foreign source income.

Senator BYRD. It seems to me you are getting into a substantive matter here.

Mr. CHRISTIAN. I believe, Mr. Chairman, virtually the identical provision was treated as a technical correction in 1978 and that is the provision that we are now asking be changed or modified. The 1978 act provided an exception to the general rule and clarified that the 1976 act had gone too far. The 1978 act provided that the income from the sale of stock would be treated as foreign source income if it resulted from the liquidation of a foreign corporation which had for the previous 3 years derived more than 50 percent of its income from operations outside the United States. The 1978 act failed to address the virtually identical transaction where the gain results not from the liquidation of the foreign corporation but from the sale of more than 80 percent of the stock of the foreign corporation. In substance, the amendment that I am suggesting to the committee would clarify the change made by the 1978 act and provide that a sale of stock would be treated the same as a liquidation.

Thank you very much, Mr. Chairman.

Senator BYRD. Thank you.

Does Treasury have a comment on that?

Mr. FERGUSON. Mr. Chairman, I have a general comment. The Technical Corrections Act, relating to the 1976 Reform Act, was included in the Revenue Act of 1978; it was tacked onto the substantive portion of the 1978 act. As a general matter, there is a substantial problem with permitting 1976 act changes that happen to be addressed in the technical corrections portion of the 1978 act to be in turn amended this year. If this procedure is permitted, we will have a snowball and will be amending a statute passed several years ago.

In this case, I have not had time to focus on the amendment. I offer this general comment as a reservation and also offer the comment that, as you suggested, we hope to keep the bill technical in nature. We would like to examine this particular amendment to see if it falls within those constraints in our view.

Senator BYRD. Thank you.

[The prepared statement of Mr. Christian follows:]

STATEMENT OF ERNEST S. CHRISTIAN, JR.

SUMMARY OF STATEMENT

1. As a technical correction to the 1976 Act, the 1978 Act provided that gain from the liquidation of a foreign corporation would, despite the more restrictive rule in section 904(b)(3)(C), be treated as foreign source income if the corporation which was liquidated derived more than 50 percent of its income from sources outside the U.S. for the immediately preceding three years.

2. The 1978 Act failed to make the same correction where the gain was derived from sale of substantially all the stock of the same corporation.

3. The 1978 Act should be corrected to provide the same rule for disposition by sale of 80 percent of the stock of a foreign corporation.

H.R. 2797 should be modified to include an additional technical correction related to the determination of foreign source income, where one corporation realizes gain from the disposition of stock in a second corporation.

Prior to the Tax Reform Act of 1976, it had been possible for a domestic corporation to increase the limitation on allowable foreign tax credits by selling at a

location outside the United States the stock of a second corporation. The capital gain on that sale was treated as foreign source income even though the corporation whose stock was disposed of derived all or substantially all its income from sources in the United States instead of from foreign sources.

In order to deal with this situation, the Tax Reform Act of 1976 amended Code section 904 to provide that the gain from disposition of the stock of the second corporation would be U.S. source income unless (i) the stock was sold in the foreign country where the second corporation had derived more than 50 percent of its income for the immediately preceding three years, or (ii) the stock was sold in a foreign country that imposed at least a 10-percent tax on the gain from disposition of the stock. Section 904(b)(3)C).

There is no apparent reason why gain from the disposition of stock of a corporation which derives most of its income from foregin sources should be treated as U.S. source income. Indeed, so long as the underlying earnings and earnings potential which give the stock its value are foreign source, it is ony logical that gain on disposition of the stock should be treated as foreign source income also. This true whether or not the corporation whose stock is sold may, by happenstance, have derived more than 50 percent of its income in one particular foreign country. it is, for example, illogical to treat as foreign source income the gain from disposition of stock of a corporation which derived 51 percent of its income in foreign country A and 49 percent in the U.S.; and not to treat as foreign source income gain from the disposition of stock in a corporation which derived 100 percent of its income from sources outside the U.S.-one-third in each of foreign countries A, B, and C. Obviously, the gain should be foreign source in any cas where the corporation whose stock is sold derived more than 50 percent of its income from sources outside the U.S.

It is also obviously the case that there is no necessity to require that the country where the stock is sold impose at least a 10 percent tax on the gain. Capital gain taxes in foreign countries are usually less than in the U.S. and in some cases nonexistent. In those cases, a difference in the characterization of income based on the nominal distinction between a 10-percent and a 9-percent rate, or even a zero rate, is purely arbitrary. In other cases, however, the capital gain tax rate in the country where the corporation derives most of its income may be higher than the U.S. rate. There is no rational reason for requiring a U.S. corporation to pay the highest possible foreign tax rate on the sale, or to make the sale in a country which imposes a tax of at least 10 percent. In both cases, the effect is merely to increase tax payments by U.S. taxpayers to foreign countries and to increase the amount of available foreign tax credit.

These defects in the Tax Reform Act of 1976 were recognized and partially corrected by Title VII of the Revenue Act of 1978 which dealt with technical corrections to the Tax Reform Act of 1976. Section 701(u)(2)(C) of the 1978 Act added Code section 904(b)(3)(D) which corrected the 1976 Act insofar as concerns gain from the disposition of stock in a liquidation. Section 904(b)(3)(D) in effect provides that gain from the disposition of stock by means of liquidation of a foreign corporation will be treated as foreign source income if the liquidated corporation derived more than 50 percent of its income from foreign sources for the immediately preceding three years. This correction of the 1976 Act eliminated the requirement that the corporation have derived more than 50 percent of its income in any one particular foreign country and eliminated the requirement that at least a 10-percent tax have been paid in the foreign country where the liquidation occurred. As previously discussed, section 904(b)(3)(D) represents the correct rule for determining the source of gain from the disposition by one corporation of stock of a foreign corporation outside the United States. Because the amendment made by the 1978 Act was a technical correction of the 1976 Act, it was made effective as of the effective date of the provision in the 1976 Act which it corrected; i.e., taxable years beginning after December 31, 1975.

The 1978 Act failed, however, to correct the 1976 Act insofar as concerns gains from the dispostion of stock in a foreign corporation when that disposition is in the form of a sale of stock instead of a liquidation. There is no apparent distinction between a liquidation of a corporation and a sale of at least 80 percent of the stock of the corporation.1 The same rule, the one provided by the technical correction in the 1978 Act, should apply in both situations.

Therefore, it is proposed that section 701(u)(2)(C) of the 1978 Act be amended to provide that a sale of at least 80 percent of all classes of stock of a corporation

1It has been suggested that a liquidation cannot artificially be arranged to occur in a low tax country, but as the analysis herein shows, and as implicitly accepted by the 1978 Act, the rational rule for determining the source of gain upon disposition relates to the source of the income derived by the corporation whose stock is sold; not to the rate of foreign tax on the sale.

would be treated the same as a liqudation. The following provision would be inserted after subparagraph (C) of paragraph (1) of section 107(a) of H.R. 2797: "(D) Subparagraph (C) of paragraph (2) of Section 701(u) of the Revenue Act of 1978 is amended

(i) by inserting "and gain from sale of stock of certain foreign subsidiaries" after "gain from liquidation of certain corporations"; and

(ii) by inserting "or the gain from the sale of at least 80 percent of all classes of stock of a foreign corporation" after "to which part II of subchapter C applies."

Because this suggested amendment is a technical correction to the technical correction made by the 1978 Act to the 1976 Act, it would have the same effective date-taxable years beginning after 1975.

I would also call the Committee's attention to one other aspect of H.R. 2797. While the amendment of section 904(b)(3)(D) which I have outlined is a technical amendment to the 1978 Act and, therefore, within the scope of this hearing, there are a large number of additional, smaller, noncontroversial amendments, not related to the 1978 Act, which also need to be enacted this year. I would strongly urge that when the Committee gets to mark-up on H.R. 2797, its scope should be expanded to include other noncontroversial, Treasury supported, amendments in order that these other much needed matters may be acted on this year also. Among these are an amendment to section 871(f) dealing with the 30-percent withholding tax on low income nonresident aliens who receive pensions from U.S. situs pensions and profitsharing plans. I have submitted a separate written statement on that amendment for inclusion in the record of these hearings.

Senator BYRD. Mr. Doumar.

STATEMENT OF ALBERT G. DOUMAR, CHAIRMAN, FIDUCIARY COMMITTEE OF THE COMMITTEE ON BANKING INSTITUTIONS ON TAXATION, ACCOMPANIED BY PATRICK A. NAUGHTON, MEMBER

Mr. DOUMAR. Mr. Chairman, my name is Albert G. Doumar and I appear before the committee in my capacity as chairman of the Fiduciary Committee of the Committee of Banking Institutions on Taxation, an organization of tax officers of the major metropolitan New York banks and with representation from the major banks throughout the United States. Mr. Naughton, a member of my committee, has joined me today.

I am a second vice president in the tax services group of the Chase Manhattan Bank, N.A. I thank the committee for the opportunity of testifying today.

These comments and recommendations relate to "adjusted itemized deductions" as they relate to estate and trust accounts, that is, IRC section 57(b)(2).

Under current law (section 57(b)(2)(A)(i)), deductions allowable in arriving at adjusted gross income would be deducted twice in order to arrive at a modified adjusted gross income for the purposes of calculating adjusted itemized deductions.

Section 104(a)(4)(F) of the technical corrections bill of 1979-H.R. 2797-would correct this defect in the current law. However, we feel that there are other technical defects in the current law which also should be taken into consideration in the technical corrections bill of 1979.

First, under current law, the deduction for personal exemption provided by section 642(b) is to be subtracted from adjusted gross income.

This is inconsistent with the treatment accorded an individual taxpayer. Section 57(b)(1) in defining adjusted itemized deductions states, in part, that it is the amount by which the sum of

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