and profits, there would be a dividend. X transfers its business assets to a new Y corporation for all of Y's stock and liquidates. Can the shareholders thereby obtain capital gains treatment at the price only of being taxed on the appreciation, if any, in their remaining investment in the business? There is at least a literal possibility that they can. Under prior law this would have been a (D) reorganization and the distributed investment portfolio would have constituted boot, taxable as a dividend. Present law appears to go out of its way, however, to prevent this result. The Government's row would be even harder to hoe if Y were first liquidated completely and then the business assets were reincorporated in a purportedly separate transaction. Part of the same problem, as already suggested, is the case of the splitup which fails to qualify under section 355, as where the X corporation divides a single business or several businesses not meeting the aging requirements of section 355, by organizing two or more new corporations to which it parcels out its assets, after which it liquidates, with or without boot. In the haste of the 1954 revision these problems could not be adequately dealt with and they were hopefully left to the courts and administrative regulation. But this approach cannot be sufficient in the long run.

With the lapse of 8 years since the restoration of the privilege of tax-free corporate divisions, enough experience has undoubtedly accumulated to justify a reexamination of the governing provisions to determine whether slightly more freedom of movement may not safely be introduced into what is today a highly rigid set of rules. Is it always necessary that the business to be separated must be at least 5 years old? Particularly in the case of divisions between shareholders, is there any reason why the fixed assets may not be spun off? Should not some way be found for permitting the breakup of a vertically integrated business? Could not the control requirements be lowered somewhat? All of these were permitted under the 1951 provision and there is no convincing evidence that tax avoidance resulted. On the other hand, some consideration should perhaps be given to providing a quantum test.

Last, but not least, is the hotly debated subject of net operating loss carryovers. There is not the slightest doubt that this subject must be exhaustively reexamined in any overall revision of the tax laws. It is here that we see the conflict between the entity theory and the beneficial interest theory in the field of corporate taxation in its most accentuated form. The basic question is, To what extent shall we allow a corporation's loss carryovers derived from past operations to survive for future use when the ownership of the corporation has changed? The privilege of inheritance via a tax-free reorganization or liquidation merely accentuates the problem; it does not change its basic nature. Many other tax attributes, such as the basis of assets and earnings and profits, to name the most conspicuous, remain fixed despite changes in ownership, and carry through from predecessor to successor corporation in a reorganization, but they lack the dramatic qualities of the loss

carryover.

Admittedly present law is uncoordinated and ineffective. It does not prevent trafficking in losses. Passing section 269 with its purpose test, the code now permits a corporation to retain its carry forwards undiminished unless within a period of 2 taxable years the per

centage of stock ownership of its 10 principal shareholders has increased by at least 50 percentage points and there has been a failure to carry on a trade or business substantially the same as that conducted before any such change in ownership. But these restrictions apply only to purchase or redemption cases. If the change of ownership results from a reorganization the percentage of required continuity of interest is reduced to 20, it does not matter whether the business is continued, and there is in no event a total loss of carry forward but only a reduction proportionate to the extent the loss corporation's shareholders fall short of meeting the 20 percent test. Moreover, there is no limitation at all in the case of a (B) reorganization or a nontaxable liquidation per se.

There is little agreement, even in principle, on what the rule should be. One school of thought would treat a carryover as an asset like any other asset of a corporation and permit it to be carried over without restriction regardless of any change in proprietary interest. This is the corporate entity theory in uncompromised form. But it is rationalized on the ground that the loss-carryover system is essentially a system of recoupment and that the loss corporation's shareholders ought to be able to recoup as well by sale of the loss as by continuing the operation themselves and applying it against future income.

At the other end of the line is another school of thought which says that the entity theory must fall, at least as to losses, if a change in proprietary interest is great enough. They take this position whether or not there is an accompanying change in business. They view the carryover provisions, not as a recoupment, but as an averaging device for the income of an economic unit. When stock ownership changes by as much as two-thirds there is a new economic unit (liquidation could be forced on the minority) in the averaging of whose income no one else's loss has a place.

Thus, one group focuses on the economic interest that incurred the loss, the other on the one that seeks to use it (the first group says this is not a windfall, since it was paid for). Is there any in-between approach? The subchapter C advisory group has proposed one based on the thought that it is the corporate tax that is under discussion, that the entity theory requires that some weight be given to the fact that the corporate taxpayer that incurred the loss is or is deemed (under the reorganization provisions) to be the same taxpayer as the one currently seeking to use the loss, but that some account must also be taken of the fact that the loss may be all out of proportion to the new investment in the business. So it is proposed to cut the loss down to size, so to speak, by limiting it to half the net worth of the business, measured by the consideration involved in the change of ownership. There is also a requirement of business continuity.

As was said at the start, with high tax rates, a separate corporate and shareholder tax with different sets of rates, and the opportunities for converting ordinary income into capital gain through dealing with or otherwise making use of one's own corporation, we cannot have a simple statute. But we can try to have an adequate one. It is believed that the problems herein briefly described are the major ones requiring attention at this time in the field of corporate distributions and adjustments.

AN APPROACH TO SUBCHAPTER C

Ernest J. Brown

I

In any comprehensive study of the Internal Revenue Code looking, among other things to "greater equity through closer adherence to the principle that equal incomes should bear equal tax liabilities," one question clearly requiring consideration is by no means limited to the provisions of subchapter C, but must nevertheless be an important factor in any proposal for revision of that area of the code if it would go beyond the purely superficial. I refer to the very basic problem of the method of formulation of the code. In recent years, perhaps beginning as early as 1942, but certainly culminating in the Internal Revenue Code of 1954 and its amendments, our taxing statutes have characteristically employed highly intricate formulations--one might say a lacy filigree of language to set forth and define the scope and limits of their operative provisions. This is a much more fundamental and significant matter than merely a style of draftsmanship. Every detail of formulation results in inclusions or exclusions from the operation of the statute, producing contrasting results which must be characterized as anomalous by any equitable standard for appraising the incidence of a taxing statute.

The purpose of detailed statutory statement is, of course, said to be the obtaining of greater certainty and predictability. But certainty and predictability are the products only to the extent that the draftsmen can foresee, and provide for, the variable patterns of human behavior and the combinations of those patterns which produce transactions subject to tax. As detail of statement increases, so also, by at least the same measure, does the requirement of foresight increase. And even if foresight could be assumed in adequate measure, increased detail of statement requires also increased technical competence in classification and separation of the treatments of differentiated transactions. One can acknowledge the existence of a considerable degree of foresight and technical competence in the drafting of recent tax legislation and still recognize that it has not been up to the excessively high level which the detail in formulation would require. An obvious example in the corporate area comes immediately to mind. It was the attempt at elaborate formulation in the (D) reorganization and section 355 which has produced the current reincorporation problem, a matter adequately dealt with under the earlier and simpler statute.

One result of the current method of formulation is that as deficiencies and anomalies appear, a continuation of this method requires even more intricate elaborations of pattern. Without referring back to some recent amendments notable in this respect, one may look to the proposals of the advisory group on subchapter C. (I do not ex

clude the proposals of the other advisory groups, but they are in areas not designated for this paper.) Many, if not all, of their proposals seem sound if taken in isolation and evaluated against the statute which has called them forth. But characteristically they result in elaboration upon elaboration, intricacy built either within or upon intricacy. One may be confident that if these proposals are accepted, still further elaboration will become necessary as the limitations and questionable results produced by these elaborations begin to appear. There is an element of irony as well as of warning in the frequency with which amendatory statutes known as technical changes acts have appeared in recent years.

I have said that the stated purpose of elaborate statutory formulation is to produce certainty and predictability. One may say with some assurance that this purpose has scarcely been achieved. To take a few examples, one may say that sections 302 (with 318), 306, 341, 346, 354, and 355 (with 368), 381, and 382 have added little, if any, to preexisting certainty, while each has brought with it a steadily increasing progeny of new uncertainties. But I believe the purpose of the current type of formulation springs from related but deeper roots. Fundamentally, it appears to spring from an attempt to eliminate, so far as possible, the necessity for responsible administration. Experience seems to be demonstrating that this is foredoomed to failure. Neither administrators nor judges readily accept the anomalous results which elaboration of formulation seems inevitably to produce. The result is not the passive or mechanistic administration which seems to have been desired, but an administration which seeks to eliminate or reduce anomaly or inequity by means of the administrator's own devising, means frequently difficult to reconcile with the authority one believes should be accorded to statutory language.

The further ironic fact is that as the elaboration of the statute seeks certainly and to avoid administrative responsibility, its very complexity calls for an ultimate surrender to administrative discretion to a degree which seems unwarranted and unwise in a taxing statute. A discretionary dispensing power is an instrument which a taxing statute should seldom award to administrators. Perhaps special considerations call for such provisions as section 367, but they must be rare. Yet, to name two examples, sections 306 (b)(4) and 355 (a) (1) (D) (ii) ultimately yield to complexity by an award of what amounts to a dispensing power to the Secretary or his delegate, and the advisory group proposes a similar provision in its proposed section 355 (a) (1) (B) (ii). Literally, these provisions call for an inquiry as to a taxpayer's state of mind, in itself a questionable matter to be determinative of fiscal responsibility, significant though it may be in the area of criminal law. In fact, the warrant is for a dispensing power exercisable without reference to any known standards. The effect of such a provision is already apparent in the rulings published under section 306. Characteristically they give the substantive provisions of that section interpretations of an operative breadth and scope which would certainly produce question if they became effective. But broad interpretation is then coupled with an exercise of the dispensing power granted by section 306 (b) (4) in those cases which, by undefined and unstated standards, are deemed meritorious. The grant of such au