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Arguments Against.-(1) Deferred compensation arrangements benefit small and medium sized companies who face economic uncertainties and possible future financial difficulties. This type of arrangement enables management to have a financial interest in the business enterprise, while at the same time it allows the company to have the use of the funds involved.

(2) Income should be taxed at the tax rates which apply to the year in which the income is received.

(3) The primary benefit of deferred compensation is forward averaging; that is, the employee is able to level out his income by shifting earnings from peak years to retirement years when he expects his other income to be lower. Forward averaging is not tax avoidance and there is no reason to prevent it.

(4) This provision will be difficult to administer.

(5) Deferred compensation benefits should be preserved as an incentive to executives.

L. ACCUMULATION TRUSTS, MULTIPLE TRUSTS, ETC.

Present law. A trust that distributes all its income currently to its beneficiaries is not taxed on this income; instead the beneficiaries include these distributions in their income for tax purposes.

An accumulation trust (a trust where the trustee is either required, or is given discretion to accumulate income for future distributions to beneficiaries), however, is taxed on its accumulated income at individual rates. When this accumulated income is distributed to the beneficiaries, in some cases they are taxed on the distributions under a so-called throwback rule. The throwback rule treats the income for tax purposes as if it had been received by the beneficiary in the year in which it was received by the trust. This throwback rule, however, only applies on the part of the distribution of accumulated income which represents income earned by the trust in the 5 years immedi ately prior to the distribution. In addition to this limitation, the throwback rule does not apply to certain types of distributions.

Problem.-The progressive tax rate structure for individuals is avoided when a grantor creates trusts which accumulate income taxed at low rates, and the income in turn is distributed at a future date with little or no additional tax being paid by the beneficiary. This result occurs because the trust itself is taxed on the accumulated income rather than the grantor or the beneficiary. This means that the income in question, instead of being added on top of the beneficiary's other income and taxed at his marginal tax rate, is taxed to the trust at the starting tax rate. The throwback rule theoretically prevents this result, but the 5-year limitation and the numerous exceptions substantially limit the effectiveness of the rule.

This avoidance device is compounded by the use of multiple truststhe creation of more than one accumulation trust by the same grantor for the same beneficiary.

House solution.-The bill provides that in the case of accumulation trusts (including multiple trusts) the beneficiaries are to be taxed on distributions of accumulated income in substantially the same manner as if the income had been distributed to the beneficiaries when it was earned by the trust. The taxes paid by the trust on the income, in

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effect, will be considered paid by the beneficiary for this purpose. A shortcut method of computing the tax on the distribution of accumulated income is provided under which the tax attributable to the distribution, in effect, is averaged over the number of years in which the income was earned by the trust. Distributions of income accumulated by a trust (other than a foreign trust created by a U.S. person) in years ending before April 23, 1964, are not subject to the new unlimited throwback rule. This provision applies to the distributions made after April 22, 1969.

The bill also provides that in the case of a trust created by a taxpayer for the benefit of his spouse, the trust income which may be used for the benefit of the spouse is to be taxed to the creator of the trust as it is earned. This provision is to apply only in respect to property transferred in trust after April 22, 1969.

Arguments For.-(1) The bill prohibits the avoidance of the effect of the progressive tax rates where a grantor creates a trust or multiple trusts, which accumulate income, pay tax on such income at a much E lower rate than would the beneficiary and then distribute it to him at a later date with little or no additional tax being paid by the beneficiary, even though he may be in a high tax bracket.

(2) Under the present law, the Internal Revenue Service has been unable to successfully resolve the problems presented by the use of multiple trusts. In some cases the courts have upheld the validity of such trusts.

(3) Accumulation trusts will be placed in substantially the same tax status as beneficiaries of trusts which distribute their income. currently.

(4) This approach provides essentially the same treatment as has been applicable to foreign accumulation trusts created by U.S. persons since the pasage of the Revenue Act of 1962.

Arguments Against.-(1) These provisions would be extremely difficult to administer and enforce by the Internal Revenue Service and on the part of the trustees.

(2) The abuse in this area involves multiple trusts and it is harsh to correct it in a way that upsets the normal fiduciary use of accumulation trusts.

(3) This provision will result in harsh tax consequences in the case of accumulation trusts which were established for nontax reasons, such as to postpone the receipt of funds by the beneficiary until he had reached a responsible age.

M. MULTIPLE CORPORATIONS

Present law. There are several provisions in the code which are designed to aid small corporations. The most important of these provisions is the surtax exemption. As the result of the surtax exemption corporations are taxed at only 22 percent, instead of at 48 percent on the first $25,000 of taxable income.

Present law permits a controlled group of corporations to each obtain a $25,000 surtax exemption if each of the corporations pays an additional 6 percent tax on the first $25,000 of taxable income. This

1The election to take multiple surtax exemptions and t is generally desirable where the group has a combine Below this figure the allocation of a single surtax gener

16 percent tax

2.500 or more.

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generally reduces the tax savings of the surtax exemption from $6,500 to $5,000.

Other provisions in the code designed to aid small corporations include: (1) the provision which allows a corporation to accumulate $100,000 of earnings without being subject to the penalty tax on earnings unreasonably accumulated to avoid the dividend tax on shareholders; and (2) the provision which allows an additional first year depreciation deduction equal to 20 percent of the cost of the property (limited to $10,000 per year).

Problem.-Large corporate organizations have been able to obtain substantial benefits from these provisions by dividing income among a number of related corporations. Since these are not in reality "small businesses" it is difficult to see why they should receive tax benefits intended primarily for small business.

House solution.-The House bill provides that a group of controlled corporations may have only one of each of the special provisions designed to aid small corporations. A controlled group of corporations is limited to one $25,000 surtax exemption and $100,000 accumulated earnings credit after an 8-year transition period. This is accomplished by gradually reducing the amount of the special provisions in excess of one which is presently being claimed by a controlled group over the years 1969 to 1975 until these excess special provisions are reduced to zero for 1976 and later years. The limitation on multiple benefits from the investment credit and first year additional depreciation, becomes fully effective with taxable years ending on or after December 31, 1969.

To ease the transition, controlled corporations are allowed to increase the dividend received deduction from 85 percent to 100 percent at a rate of 2 percent per year. In addition, controlled corporations who elect to file consolidated returns, may deduct net operating losses for a taxable year ending on or after December 31, 1969, against the income of other members of such group. Present regulations allow such losses to be deductible only against the income of the corporation which sus tained the losses.

The bill also broadens the definition of a controlled group of corporations.

Arguments For.-(1) Large economic units have been able to reap unintended tax benefits through the use of multiple corporations. Often the only reason for using multiple corporations is to take advantage of the surtax exemption or the $100,000 accumulated earnings credit. This may lead to uneconomic practice and a great waste of energy by taxpayers, their counsel, and the Internal Revenue Serv ice. By structuring a large economic unit so as to generate no more than $25,000 of taxable income in each component corporation, the maximum marginal tax can be held at 28 percent instead of 48 percent, thus, avoiding tax of $5,000 for each corporation.

(2) Even where there are good business reasons for using multiple but related corporations they still should not be given the tax benefits designed for small business.

(3) This provision will prevent the artificial incorporation of many companies that actually perform the same or similar operations under one management.

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(4) Under the present law, large businesses, such as various chain. stores, are able to take advantage of the multiple surtax exemption while competing smaller businesses in local communities are not. This presents an element of unfair competition which the bill eliminates. Arguments Against.—(1) The repeal of the multiple surtax exemption would discourage legitimate and normal expansion of growing businesses within a controlled group which is established for sound business purposes.

(2) Multiple corporate structures arise for bona fide business reasons and not for tax reductions. Such corporations are formed to limit public liability, to comply with State requirements and to "tailor" themselves to the particular business operation involved. The tax law should not penalize these legitimate purposes.

(3) A new venture is often unprofitable in the early operation. By placing the new venture in a separate corporation, the losses can be recouped faster via the $25,000 surtax exemption and the other benefits allowed.

(4) No competitive unfairness exists within the industries, some of whose members have traditionally been organized into separate corporations.

N. CORPORATE MERGERS

1. Disallowance of Interest Deduction in Certain Cases

Present law. Under present law a corporation is allowed to deduct interest paid by it on its debt but is not allowed a deduction for dividends paid on its stock or equity.

Problem. It is a difficult task to draw an appropriate distinction between dividends and interest, or equity and debt. Although this problem is a long-standing one in the tax laws, it has become of increasing significance in recent years because of the increased level of corporate merger activities and the increasing use of debt for corporate acquisitions purposes.

There are a number of factors which make the use of debt for corporate acquisition purposes desirable, including the fact that the acquiring company may deduct the interest on the debt but cannot deduct dividends on stock. A number of the other factors which make the use of debt desirable are also the factors which tend to make a bond or debenture more nearly like equity than debt. For example, the fact that a bond is convertible into stock tends to make it more attractive since the convertibility feature will allow the bondholder to participate in the future growth of the company. The fact that debt is subordinated to other creditors of the corporation makes it more attractive to the corporation since it does not impair its general credit position.

Although it is possible to substitute debt for equity without a merger, this is much easier to bring about at the time of the merger. This is because, although stockholders ordinarily would not be willing to substitute debt for their stock holdings, they may be willing to do so pursuant to a corporate acquisition where they are exchanging their holdings in one company for debt in another (the acquiring) company. In summary, in many cases the characteristics of an obligation issued in connection with a corporation acquisition make the inter

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in the corporation which it represents more nearly like a stockholder's interest than a creditor's interest, although the obligation is labeled as debt.

House solution.-In general, the bill disallows a deduction for interest on bonds issued in connection with the acquisition of a corporation where the bonds have specified characteristics which make them more closely akin to equity.

The disallowance rule of the bill only applies to bonds or debentures issued by a corporation to acquire stock in another corporation or to acquire at least two-thirds of the assets of another corporation. Moreover, the disallowance rule only applies to bonds or debentures which have all of the following characteristics: (1) they are subordinated to the corporation's trade creditors; (2) they are convertible into stock; and (3) they are issued by a corporation with a ratio of debt to equity which is greater than two to one or with an annual interest expense on its indebtedness which is not covered at least three times over by its projected earnings.

An exception to the treatment provided by the bill is allowed for up to $5 million a year of interest on obligations which meet the prescribed test.

This provision of the bill also does not apply to debt issued in taxfree acquisitions of stock of newly formed or existing subsidiaries, or in connection with acquisitions of foreign corporations if substantially all of the income of the foreign corporation is from foreign

sources.

This provision applies to interest on indebtedness incurred after May 27, 1969.

Arguments For.-(1) This provision helps stem the tide of conglomerate mergers, which have increased phenomenally in recent years and which pose a threat to our economic well-being, by denying the interest deduction with respect to certain types of indebtedness incurred by corporations in acquiring the stock of other entities.

(2) The corporate bonds and debentures used in conglomerate acquisitions have characteristics, such as convertibility and subordination, which delineate the interest in the corporation which they represent more as equity than as debt. This bill properly treats them as equity interests.

(3) Advantageous tax provisions have spurred the "urge to merge" with the result that the Federal Government bears a portion of the carrying costs of many conglomerate acquisitions. This provision withdraws one of those advantages.

Arguments Against.-(1) Mergers are part of the American business complex. They represent growth and, in many instances, rejuvenate businesses and management, and nurture higher degrees of efficiency and competence.

(2) Debentures and bond issues represent debt in the business community and they should not be characterized as equity interests for tax purposes.

(3) If Congress desires to inhibit the merger movement, it should make all reorganizations taxable events-regardless of whether they are voluntary or involuntary, horizontal, vertical or pure conglomerate. Congress should not limit its examination to the tax treatment of conglomerate mergers, but should also consider those sections of the Code