This rule applies where the interest constitutes

income not

effectively connected with the alien's or corporation's trade

or business in the United States. This extension would also apply to the existing relief from Federal estate tax for such deposits by nonresident aliens with U.S. banks.

Because of balance of payments considerations, the

Administration recommended in April that these relief provisions not be permitted to expire at the end of 1972 but be continued indefinitely. We would prefer complete removal of the expiration date so long as the balance of payments problem exists, but the provision of the House bill extending the provisions through 1975 seems adequate for the time being. Under current law, interest paid by U.S. branches of

foreign banks to nonresident aliens or foreign corporations ordinarily is not subject to U.S. income tax whether or not the deposit is effectively connected with the depositor's U.S. trade or business. In the case of U.S. banks, the interest income is free of tax only if the deposit is not so connected.

While the Foreign Investors Tax Act of 1966 recognized
that U.S. business-connected deposits in U.S. branches
of foreign banks should be subject to U.S. tax to the
same extent as if the deposits were made in a U.S.
bank, that Act provided that such deposits in U.S.
branches of foreign banks would not become taxable
until January 1, 1973. We see no reason for any delay
in achieving parallel treatment,, and therefore recommend
that interest paid by U.S. branches of foreign banks
be treated the same as interest paid by U.S. banks
effective for the calendar year following enactment of

the bill. A similar problem arises with respect to
deposits in U.S. branches of foreign banks by nonresident
aliens for purposes of the estate tax liability, and

we recommend similar action.

20. Regulated Utilities (Sec. 451)

Regulated public utility companies in general account

for depreciation on a straight-line basis for purposes of the rate-making process. Where accelerated depreciation is

taken for tax purposes, the actual Federal tax paid is lower than.

the tax liability which would result from the straight-line depreciation taken for rate-making purposes. Some regulatory commissions permit taxpayers to "normalize" their tax for rate-making purposes; that is, they treat as a cost the tax which would have been imposed if straight-line depreciation had been used and treat the difference between this amount and the actual tax as a reserve for future taxes. In

other situations the regulatory commissions require

companies to take into account in determining the

current cost of their operations only the actual tax paid, with the result that the tax reduction due to accelerated

depreciation is "flowed through" to the customer as a reduction in price, thus further reducing profits and income tax revenues. Many commissions are presently switching from normalization to flow-through, and others are even imputing the use of accelerated depreciation where the utility in fact is using straight-line depreciation for tax purposes. This trend will force utilities to switch to accelerated depreciation for tax purposes, and the "flow through" consequences will have a double effect in reducing tax revenues, since it results in a reduction in utility gross revenues as well.

Under the bill gas and oil pipeline, telephone, gas and electric utility companies, and water and sewage disposal companies would be allowed accelerated depreciation only if they "normalize" the tax saving for rate-making purposes. Thus they could not be required by regulatory agencies to "flow through" their tax savings to their consumers at the expense of Federal revenues. An exception would be provided for utilities which are presently using "flow through." Where straight-line depreciation is being taken with respect to property constructed or placed in service before December 31, 1969, no accelerated method will be permitted.

We support this provision of the bill. It would generally "freeze" the present situation, and prevent a major revenue loss estimated as high as $1.5 billion annually, which

would result if the present trend by regulatory commissions

1

toward "flow through" were allowed to continue.

There is one transitional problem which should be corrected. In determining whether a utility will be allowed to use accelerated depreciation and "flow through," the bill looks to the taxpayer's latest return filed prior to July 22, 1969. We recommend that

a utility be granted this right if, as of July 22, 1969, the utility had established by book entries or certain other means that it was adopting accelerated depreciation and "flow through".

21. Effect of Accelerated Depreciation on Corporate Dividends (Sec. 452)

Under present law, a dividend is a distribution out of earnings and profits. A distribution exceeding the amount of earnings and profits is not taxed as a dividend but treated as a return of capital. Through the use of accelerated depreciation many companies, particularly in the utility and real estate fields, have been able to distribute substantial amounts to shareholders without current tax to the shareholders.

The bill adopts our recommendation made in April to require companies to compute earnings and profits by using