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corporations, which are now at a distinct disadvantage in comparison with partnerships.
If such a deduction in respect of distributed income is approved, we recommend the repeal of section 220.
The present law provides that a taxpayer may report his income on the installment basis, at his option, and include in income the “proportion of the installment payments actually received in that year which the total profit realized or to be realized when the payment is completed bears to the total contract price.” The regulations, based on the law and its legislative history, provide that in the period subsequent to the change from the accrual basis to the installment basis, all installment payments must be included in income regardless of the fact that such payments may have been previously reported on the accrual basis and have been subjected to tax. The law also provides that in the case of sale of real property the installment basis can not be used unless the initial payments received in the taxable year do not exceed 25 per cent of the selling price. This limitation is not applied to sales of personal property, except in the case of casual sales.
An investigation of the operation and effect of the installment sales provisions has been made, since many objections have been raised by taxpayers, especially in regard to the features of alleged double taxation and the 25 per cent limitation mentioned above.
Whenever a change of method is made, one of two alternative courses must be adopted. If profits already reported are excluded, the tax in the year of change will be seriously subnormal. If the profit is not excluded there is a certain measure of double taxation, but so long as the business remains stable or increases, the tax will still be less than if no change had been made. The burden is felt only where the business seriously declines or is abandoned. A provision which necessarily subjected taxpayers to double taxation would ordinarily be objectionable, but this objection does not seem to us to apply to an optional method which will probably not be adopted unless the advantage to the taxpayer offsets any incidental disad ntages. On the other hand, there is no substantial ground in equity for making the payment of a low rate of tax in a previous year a ground for permitting a taxpayer to return an altogether subnormal amount of income in a later high-tax year.
The double-taxation feature in the past has not, in our opinion, imposed any seriously unjust burden. This conclusion is strongly upported by the fact that the original regulations embodied this nature, yet the option was freely availed of under those regulations. The adoption of the method has always been optional. The substance chf the grievance of complaining taxpayers in regard to the past in been Cy seems to be that under amended regulations, for a time in aboue, other taxpayers of the same class received much more favorable
Statment. It does not, however, seem that this inequity as between putipayers in the same class should be remedied by a further concestion to the class at the expense of the general body of taxpayers. thy here, however, returns have been filed and accepted on the basis of regulations more favorable than the original regulations or the present law no additional tax should, in our opinion, now be assessed by reason of the subsequent change of regulations or law.
An arbitrary limitation on real property sales similar to the 25 per cent limitation is necessary, because there is a fundamental difference between the business of a real property dealer and a personal property dealer.
There are exceptional classes of cases where the receipt of 25 per cent cash in a real-estate sale clearly does not create a substantial assurance of the subsequent recovery of the deferred purchase money and some relief in such cases is called for. Such relief might be governed by the application of the principle of article 46 of regulations 69, which provides that,
If the obligations received by the vendor have no fair market value, the payments in cash or other property having a fair market value shall be applied against and reduce the basis of the property sold, and, if in excess of such basis, shall be taxable to the extent of the excess. Gain or loss is realized when the obligations are disposed of or satisfied, the amount being the difference between the reduced basis as provided above and the amount realized therefor.
It seems desirable, however, that specific authority should be given to the commissioner to apply article 46 to cases to which it is not now being applied. It is suggested that there be added to section 212 a clause, embodying the rule above quoted from article 46 and authorizing its application wherever the obligations received by the vendor had no fair market valwe determinable with reasonable certainty by the application of standards customarily accepted in business practice.
It is not uncommon in this country to find one corporation owning all or substantially all of the stock of one or more subsidiary corporations. . In other cases the same group of individuals own the stock of several corporations in substantially the same proportions. Prior to the war period, at least in the first case, consolidated balance sheets were recognized as properly reflecting the position of the affiliated corporations, but no standard accounting method was generally recognized. Largely on account of invested capital computations and the danger of artificial intercompany transactions, the regulations of 1917 and the revenue acts since 1918 have recognized the principle of affiliation.
This section of the law has given trouble in the way of interpretation and administration.
While the excess-profits tax was in force, the consolidated return was indispensable as a method of preventing avoidance and evasion. Under the income tax the consolidated return renders the important service of permitting a loss sustained by one corporation to be charged against profit or net income realized by another corporation affiliated with it. Where one corporation owns 95 per cent or more of the stock of another corporation it is in accordance with both equity and sound policy to charge the loss of one against the profit or gain of the other. This beneficial feature, however, can be preserved without retaining the manifold complications and difficulties of consolidated returns and accounting. We, therefore, recommend :
1. That the consolidated return as such be discontinued or abandoned.
2. In any case in which an affiliated corporation sustains a loss for a given taxable year, such loss, with the written consent of the corporation sustaining it, may be offset or charged against the net income of any other corporation or corporations with which it is affiliated, provided that such loss be not thereafter carried forward to any subsequent year or otherwise availed of.
3. That affiliation be confined to so-called class A affiliations by repealing clause (2) of section 240(d), which provides that two or more domestic corporations shall be deemed to be affiliated if at least 95 per cent of the stock of two or more corporations is owned by the same interests.
4. That a reasonable interval of time be given affiliated corporations to adjust themselves to this change. It is suggested that these amendments should not take effect before January 1, 1929.
FEDERAL TAX LIENS
The law to-day has no provision for releasing a tax lien on the giving of a bond. There is difficulty in selling or mortgaging property subject to a Federal tax lien. If the taxpayer has no other resources from which to pay the tax, the lien may tend to deter quick collection. Moreover, in the case of real-estate dealers the lien practically stops the taxpayer's business. The general situation is objectionable particularly in certain areas which at the present time are suffering from business depression. Legislation is recommended authorizing the release of a tax lien on the giving of a surety bond satisfactory to the commissioner in an amount not more than twice the tax due.
Where an estate-tax lien is released the commissioner may issue a certificate to that effect. The certificate facilitates proof of titles and is desirable for other reasons. It is recommended that provision be made for the issuance of a similar certificate where an income tax lien is released. It is believed that there is ample authority for such a certificate at the present time; but in view of the specific authority for estate-tax cases in section 315 (a), a similar provision relating to income-tax cases is recommended.
The law now provides that the lien shall extend to all property and rights in property owned by the taxpayer, and it does not in terms authorize the filing of a lien against specific property. It seems desirable in some cases to permit filing the lien against a particular parcel or parcels of property. If a taxpayer owns five lots of land each clearly worth $10,000, there seems to be no reason for filing a small $1,000 tax lien against all parcels. One would afford ample security. The commissioner should be authorized, where he is satisfied as to the security, to file the lien against specific parcels of real estate or other property: Where there is reasonable doubt as to the security, the commissioner should be allowed to file a general lien against all property as under the present law.
TRANSFEREES OF PROPERTY
(Section 280) If a taxpayer transfers his property (other than by a bona fide sale) and thus is unable to pay a proposed additional tax, it becomes necessary to proceed against the transferee, whose liability for the tax is based ordinarily on the so-called “trust-fund” doctrine. Such transfers commonly occur in the everyday dissolution of corporations and distributions of estates, though occasionally property transfers are made for the specific purpose of evading payment of the tax.
Prior to the 1926 Act, collection procedure against the transferee (except where a lien had attached before the transfer) was by a suit at law or in equity in the Federal district court. Though section 280 does not purport to change the transferee's liability, it does introduce a new method of collection. In effect the transferee is subjected to the same collection procedure as though he were the taxpayer. A deficiency letter is sent to him, he may appeal to the Board of Tax Appeals, collection may be enforced by distraint if he does not appeal, and he is subject to jeopardy assessments.
The constitutionality of the section has been questioned and a district court in Kentucky has held it unconstitutional. (Owensboro Ditcher & Grader Co. v. Lucas, 18 F. (2d.) —.) The case has been appealed.
Section 280 appears to be the exclusive remedy at the present time; that is, the commissioner no longer may proceed against transferees by suit in the lower Federal courts. The docket of the Board of Tax Appeals is congested. Moreover, in certain kinds of cases it seems desirable to permit the commissioner to bring suit in the Federal courts rather than to proceed under section 280. This is particularly desirable where the transfer was made in good faith and where the liability ought to be apportioned among many transferees. It is recommended that the procedure by suit be restored as an alternative method of collection.
A transferee should have the same rights as the transferor with respect to bureau hearings, copies of returns and documents, and general administrative procedure. It is understood that at the present time the practice of the bureau is to give these rights to the transferee.
An important point of difference between collection by suit in the Federal courts and under section 280 is that under the former method the burden of proof was on the Government while in the latter it is on the transferee.
It is believed that a change should be made in the present law with respect to the burden of proof in proceedings before the board under section 280. There are two distinct elements; first, proof that there was a transfer at such a time and place and under such circumstances as to give rise to liability on the part of the transferee for the transferor's tax; second, proof that the tax was actually due and owing from the transferor. At the present time the transferee has the burden as to both elements, and this frequently works hardships which are almost intolerable. It is recommended that the burden on the first element be placed on the commissioner.
The transferee should have access to the books, records, and other evidence bearing on the transferor's liability for the tax. Existing law authorizes the issuance of a subpoena to bring these records before the board at the trial, but this does not enable the transferee properly to prepare his case. Consideration should be given to a provision authorizing a preliminary examination of this evidence. It is suggested that a transferee who has appealed to the board should have the right to compel the transferor or any custodian of the transferor's books, records, and documents to produce such evidence prior to the trial for inspection by the transferee, the board to be first satisfied that the evidence is necessary and that it would not be an undue burden to the transferor or custodian to produce the evidence at a time and place designated.
Section 280 is capable of harsh application, and many complaints have been received about it. Properly employed, it serves a useful purpose, particularly in cases of colorable transfers. Nevertheless, it deprives the transferee of important advantages which he would have as a defendant in the Federal courts. Chief among these is the right by appropriate process to bring the transferor and other transferees before the court so that orders and decrees as to proportional liability, contribution, and the like may be made in the one proceeding. It is recommended that careful consideration also be given to possible methods of giving these rights to the transferee before the board, and further investigation is being made as to specific methods of accomplishing this end, the results of which will be incorporated in a supplemental report.
There are certain technical matters, such as the statute of limitations in its application to section 280, which are discussed in Part III.
THE BAR OF THE STATUTE OF LIMITATIONS
(Section 1106 (a))
Prior to the enactment of the 1926 Act there was doubt as to the legal effect of the bar of the statute of limitations. Was the taxpayer entitled to recover amounts paid after the statutory period if prior thereto he owed that amount of additional tax? Was it important whether the payment after the period was made freely or under duress? These and related questions were the subject of section 1106(a). Unfortunately the section appears to contain elements of doubt which should be clarified. The principal results of the recommendations submitted is that the bar of the statute, whether against the Government or the taxpayer, shall have the same general effect as though the barred obligation had been satisfied (so far as collecting it after the expiration of the period is concerned), and that payments by either after the period shall be deemed to be overpayments to be recovered in the same general manner as an ordinary overpayment within the period. Another feature of the recommendations may be illustrated: If, within the proper time the taxpayer files a claim for refund of $300, because of a non-taxable item included in his return and if after the statute has barred additional assessments it is found that he owes $500 because of excessive depreciation, neither party should be permitted to enforce any payment from the other. This is subject to the qualifications stated under the next heading
It is thought unw.se, for administrative reasons, to distinguish between payments under duress and voluntary payments. For a more complete statement of the general problem and the recommendations, reference may be had to Part III of the report.