THE REVENUE BILL OF 1937 AUGUST 13, 1937.-Committed to the Committee of the Whole House on the state of the Union and ordered to be printed Mr. DOUGHTON, from the Committee on Way and Means, submitted the following REPORT [To accompany H. R. 8234] The Committee on Ways and Means, to whom was referred the bill (H. R. 8234) to provide revenue, equalize taxation, prevent tax evasion and avoidance, and for other purposes, report it back to the House without amendment and recommend that the bill do pass. The need for such a bill was called to the attention of the Congress by the President of the United States in his message dated June 1, 1937. After investigating the matters contained in the President's message, the Joint Committee on Tax Evasion and Avoidance submitted a report to the Congress under date of August 5, 1937, pursuant to Public Resolution No. 40, Seventy-fifth Congress. The report of the Joint Committee on Tax Evasion and Avoidance contains the following significant statement: In order promptly to consider and investigate the matters brought to the attention of the Congress by the above message a joint resolution was introduced providing for the creation of a Joint Committee on Tax Evasion and Avoidance. This joint resolution became law on June 11, 1937. It provided for a joint committee to be composed of six Members of the Senate who are members of the Committee on Finance, and six Members of the House of Representatives who are members of the Committee on Ways and Means. The requisite powers were given the joint committee to hold hearings, to examine documents, and to take testimony. Power was also given the joint committee to examine income-tax returns and related matters. Section 2 of the joint resolution referred to makes it the duty of the joint committee to investigate the methods of evasion and avoidance of income, estate, and gift taxes, pointed out in the message of the President transmitted to Congress on June 1, 1937, and other methods of tax evasion and avoidance, and to report to the Senate and the House, at the earliest practicable date, and from time to time thereafter but not later than February 1, 1938, its recommendation, as to remedies for the evils disclosed by such investigation. The joint committee having considered the subject matter submitted to it submits the following report: The committee has held public hearings, beginning on June 17, 1937. Since that date it has been almost continuously engaged in holding such hearings, or in considering the subject of tax evasion and avoidance in executive session. Because of lack of time the committee has confined itself for the present to those subjects which may be directly classified under the head of evasion or avoidance, leaving out of account subjects such as community property or percentage depletion which will receive further consideration by the joint committee. The committee, as a result of its investigations, believes it is imperative at this time that legislation should be enacted in regard to the following subjects, with respect to which it has been shown that certain serious loopholes exist: 1. Domestic personal holding companies. 2. Incorporated yachts, country estates, etc. 3. Incorporated talents. 4. Artificial deductions for losses from sales or exchanges of property. 5. Artificial deductions for interest and business expense. Detailed recommendations are made on these subjects in the body of this report. The committee has examined the problem of certain alleged tax-saving devices based on single-premium life-insurance policies issued by fake foreign insurance companies. The committee believes the existing law is adequate to reach these cases. The subject of pension trusts has been passed over for the present because it does not appear to have resulted in much loss of revenue to date. However, this matter will be reported on later. The printed record of the public hearings held by the committee amply su18tains the statements made by the President of the United States in his message. The committee strongly urges that legislation along the lines recommended be enacted at the earliest possible moment in order to protect the revenue, and in order that all may bear their fair share of the tax burden. Your committee has given careful consideration to the message of the President of the United States and to the report of the Joint Committee on Tax Evasion and Avoidance. Your committee believes that the evidence presented before the joint committee and the Ways and Means Committee fully substantiates the statements made by the President of the United States in his message to the Congress. Your committee concurs in the recommendations made by the joint committee with respect to legislation in all major respects and the bill is designed to carry out these recommendations. The bill is divided into six titles as follows: I. Personal Holding Companies. II. Foreign Personal Holding Companies. IV. Trusts. V. Nonresident Aliens. VI. Miscellaneous Provisions. A detailed discussion of each of these titles follows: TITLE I-PERSONAL HOLDING COMPANIES Section 1 of title I of the bill substitutes, for the taxable years to which it is applicable, a new title IA for the provisions of existing law relating to personal holding companies. Under the new provisions title IA is divided into 10 sections-that is, sections 351 to 360, inclusive. A discussion of each of these sections follows: NEW SECTION 351, 1936 ACT-SURTAX ON PERSONAL HOLDING COMPANIES Under existing law, personal holding companies are subject to a surtax at rates ranging from 8 percent upon undistributed adjusted net incomes not in excess of $2,000 to 48 percent in the case of undistributed adjusted net incomes in excess of $1,000,000. These rates are sufficiently low to permit individuals in the high surtax brackets to secure considerable tax savings, particularly through the formation of multiple personal holding companies. To prevent wealthy individuals from securing tax advantages through the formation of multiple personal holding companies, it is necessary that very high minimum rates be imposed upon personal holding companies. Accordingly, under this section, it is proposed to tax the undistributed adjusted net income of personal holding companies not in excess of $2,000 at a rate of 65 percent, and the remainder over $2,000 at a rate of 75 percent. NEW SECTION 352, 1936 ACT-DEFINITION OF PERSONAL HOLDING COMPANY Under existing law, a corporation is taxable as a personal holding company for any taxable year in which it derives 80 percent or more of its gross income from certain specified sources (mainly investments) and at any time during the last half of such taxable year more than 50 percent in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals. This rule has not been entirely satisfactory. It permits a corporation which is taxable as a personal holding company in one year to escape tax entirely as a personal holding company in the following year by making a slight change in the character of its income (for instance, in the following year, the company might derive 79 percent of its gross income from such specified sources instead of 80 percent). This is true although there was no change in the stock ownership of the company, and the change in the sources of the income was so slight as not to affect the company's being availed of as a personal holding company. To overcome such defects, this section of the bill provides that if in any taxable year the personal holding company income, as defined in section 353 of new title IA, equals 80 percent or more of the total gross income of the personal holding company, the minimum percentage for each subsequent taxable year shall be 70 percent instead of 80 percent until (1) a year in which the corporation does not meet the stock-ownership test (namely, that at any time during the last half of the taxable year, more than 50 percent in value of its outstanding stock is owned, directly or indirectly, by or for not more than five individuals) or (2) for each of three consecutive years less than 70 percent of the gross income is personal holding company income. For example, suppose a corporation during the last half of each of its taxable years (the calendar years 1937, 1938, and 1939) has more than 50 percent of its outstanding stock in point of value owned by five or less individuals. For the calendar year 1937, 85 percent of its gross income constitutes personal holding company income as defined in the bill. For the calendar year 1938, such personal holding company income represents only 60 percent of its total gross income, and for the calendar year 1939 such personal holding company income constitutes 79 percent of its total gross income. Under existing law, this company is taxable as a personal holding company for the calendar year 1937 but not for the calendar years 1938 and 1939. Under the bill as reported, such a company is taxable as a personal holding company for both the calendar years 1937 and 1939 but not for the calendar year 1938. If, however, the personal holding company income constituted less than 70 percent of the company's gross income for the years 1938, 1939, and 1940, it would not thereafter be taxable as a personal holding company until a taxable year in which 80 percent or more of its gross income constituted personal holding company income. Moreover, if in any taxable year such a corporation ceased to be a personal holding company because it failed to meet the stock-ownership test (regardless of whether it met the gross income test), it would not thereafter be taxable as a personal holding company until a taxable year in which it again satisfied the stockownership test and in which at least 80 percent of its gross income constituted personal holding company income. In all cases the first year for which the determination of its income is applied to ascertain whether in later years it is a personal holding company (even though less than 80 percent of its gross income is personal holding company income) is the first year for which new title IA applies to it. In defining a personal holding company this section, like section 351 of existing law, exempts from the definition charitable and other corporations (exempt under sec. 101 of the Revenue Act of 1936 from the normal tax and the surtax on undistributed profits), banks as defined in section 104, life-insurance companies, and surety companies. Foreign corporations meeting the definition of a personal holding company under new title IA are also subject to this surtax. Section 351 of existing law subjects foreign corporations to its provisions. However, a foreign personal holding company, as defined in section 331 of supplement P (see sec. 201 of the bill), is, with respect to a taxable year ending after the date of the enactment of this bill, excluded from new title IA for such year. NEW SECTION 353, 1936 ACT PERSONAL HOLDING COMPANY INCOME In order for a corporation to be classed as a personal holding company, one of the conditions imposed by existing law is that at least 80 percent of its gross income for the taxable year must be derived from royalties, dividends, interest, annuities, and, except in the case of regular dealers in stock or securities, gains from the sale of stock or securities. In section 353 of new title IA, your committee included all of these items under the term "personal holding company income" and adds to that definition certain other items. These items will now be discussed in detail: Subsection (a) includes as items of personal holding company income "dividends, interest, royalties, and annuities." These items are the same as those used for the purpose of the 80-percent test under existing law. "Royalties" as used herein has the same meaning as in the case of royalties referred to in section 351 of existing law and, therefore, includes iacome from copyrights. Subsection (b) includes as personal holding company income gains from the exchange of stock or securities. This is merely a clarifying amendment to carry out the intent of existing law. Subsection (c) includes as personal holding company income, gains derived from futures transactions in commodities on or subject to the rules of boards of trade and exchanges. However, an exception is made in the case of gains on bona-fide hedging transactions derived by corporations engaged in good faith in producing, processing, merchandising, or handling such commodities. Gains from cash transactions are not included. Evidence was submitted to the joint committee which disclosed that corporations, which in all respects except the income test were personal holding companies, derived enough of their income from speculative futures transactions to enable them to fall outside the income test. Subsection (d) includes as personal holding company income, income required to be taken up by a corporate beneficiary from an estate or trust as well as gains from the sale or other disposition of any interest of the corporation in an estate or trust. The present law makes no reference to income of corporations from estates or trusts. It is possible, therefore, that the personal holding company section might be circumvented by creating a trust which pays its income to the corporation. Under such circumstances, it might be contended that under existing law a corporation receiving more than 20 percent of its gross income from estates and trusts was not a personal holding company. By including trust and estate income within the definition of personal huld'ng company income, your committee amendment closes this possible loophole. Subsection (e) includes in personal holding company income certain amounts received by a corporation from contracts for personal services (including gain from the sale or other disposition thereof). Existing law contains no comparable provisions. To make such income includible as personal holding company income, the following conditions must exist: (1) Some person other than the corporation must have the right to designate (by name or by description) the individual who is to perform the services, or the individual who is to perform the services must be designated (by name or description) in the contract; and (2) The individual who has performed, is to perform, or may be designated (by name or by description) as the one to perform such services, must at some time during the taxable year of the corporation own, directly or indirectly, 25 percent or more in value of the outstanding stock of the corporation. Evidence was presented to the committee of instances where an individual with unique talents, whose compensation for personal services was large, formed a corporation which contracted with him for his services at a relatively modest figure, and then contracted out his services with third persons at a much higher figure. The corporation accumulated the difference between the sums received and the sums paid to the individual, and under existing law paid only the corporate normal and undistributed-profits taxes thereon, since the corporate income from its contract for services did not come within the classes of income described in section 351 of existing law. It is necessary to provide that the individual may be designated by description as well as by name, as some contracts may so describe the individual that his identity could not be mistaken, although his name was not mentioned. The provision that some third party must have the right to designate who shall perform the services contracted for, or that the person to perform the services must be designated in the contract, will prevent this rule from applying in general to operating corporations engaged primarily in rendering personal services and which necessarily enter contracts to render such services, selecting such members of their staff as they desire to render such services. Thus, corporations which let out the services of architects, engineers, and advertisers would not as a general rule be required to report such income as personal holding company |