thority is not wise legislation; the routine use of it is not wise administration.

The need for responsible administration of taxing statutes by both the executive and the judicial branches of the Government is unlikely to be eliminated by elaborate statutory formulation. The surrender to administrative dispensing power which appears as the ultimate resolution of elaboration is a remedy of desperation in a taxing statute. There is still another element to be considered. The income tax is administered not only by representatives of the Government. It is necessarily administered also by taxpayers, their lawyers, accountants, and bookkeepers the country over. An income tax statute for a country of the economic complexity of ours cannot be simple. But it is worth considering whether private participation in responsible administration is not affected by something analogous to a law of diminishing returns as the statute develops, or has developed, beyond what is the acceptable point of intricacy and elaborateness.

II. REORGANIZATION AND RELATED EXCHANGES

Presumably every exchange of property could constitutionally be taken as an occasion on which gain or loss cognizable for income tax purposes could be computed. Indeed, it is more than possible that without delaying until sale or exchange of assets, periodic computations of changes in worth could be required and made significant in the computation of income subject to tax. But to state the constitutional possibility of such programs is not to suggest their legislative or administrative wisdom. At least since 1918, though the general rule has been that gain or loss was to be recognized upon the sale or exchange of property, there have been statutory provisions for nonrecognition upon certain exchanges. Indeed, if it were necessary to choose between extremes, it would seem preferable for the economy and no great loss for the Treasury to choose the opposite general rule and, assuming provision for continuity of basis, to recognize gain or loss on an exchange only as the taxpayer received cash or consumable goods, the consumption of which gave rise to no deduction for tax purposes. Obviously in the latter instances it would be appropriate to treat receipt as a taxable transaction, though even there we have in recent years provided for nonrecognition in certain instances.

But we have not had to choose extreme positions, and we have not done so. We have, in the reorganization and related sections, provided for nonrecognition of gain or loss on exchanges where the exchange resulted in a continuity of investment, as that concept has been set forth in the statute. That there should be some such provision-broad or narrow in scope as one may choose has seemed wise, and almost necessary, if, in Chairman Mills' phrase, we are to have "a tax system which interferes as little as possible with the operation of the free market mechanism in directing resources into their most productive uses." The prospect of tax liability resulting from a possible or projected exchange is undoubtedly to some perhaps immeasurable extent a deterrent to the taxpayer who is considering the exchange, particularly where it is to produce no cash to him, and money to pay the tax will have to be raised from some other source or transaction. Very roughly speaking, our provisions for tax-free ex

changes, as we have called them, have served something of the same economic purpose that exemption of capital gains does in other taxing systems, while preserving to the Treasury the potentiality of revenue upon the ultimate liquidation of the investment.

We are, however, faced with the continuing legislative choice whether the provisions for tax-free exchanges should be broad or narrow in scope. It is possible to argue that they should be narrow, and narrower than they have been. See Hellerstein, "Mergers, Taxes and Realism," 71 Harvard Law Review 254 (1957). One of the arguments tending to this conclusion is that the provisions for nonrecognition of gain encourage mergers and other reorganizations which result in an unfortunate trend toward monopoly. If all, or even the predominant majority, of reorganizations had economic consequences which were accepted as unfortunate, there would be little reason to lower tax barriers to such transactions generally. But few would contend that all reorganizations have unfortunate economic implications, and about many such transactions there is obvious room for difference of economic opinion. Certainly some reorganizations do direct resources into channels productive of economic growth. If this is so, it seems unlikely that a revenue act can be adequately selective by its terms to encourage the reorganizations which will result in growth, and to discourage those which will have monopolistic or other economically unfortunate tendencies. Rather than narrowing the scope of the nonrecognition sections in the revenue acts for the purpose of applying nonselective collateral sanctions upon mergers, it would seem better to obtain enforcement of the antitrust and related statutes by reliance upon those agencies of Government which are responsible in that area and which presumably can make intelligent differentiation between transactions according to standards relevant to the statutes they are charged with administering and enforcing.

Starting with a unitary concept of the unifying reorganization, and similar treatment of the control, or divisive reorganization, the revenue acts during the past 25 years have undergone the imposition of a series of differentiations and limitations. In 1934, the terms permissible in a statutory merger were differentiated from those allowed in the so-called practical mergers, the (B) and (C) reorganizations. No reason was suggested for this differentiation then, and none has been advanced to carry conviction since then. The 1954 code perpetuates this difference, makes new and inexplicable differentiations between the (B) and the (C) reorganization, and creates a highly intricate system of controls over the (D), or divisive, reorganization and related transactions. Certainly, the Advisory Group is correct in proposing to simplify this structure, and at least to the extent of that simplification broadening the concept of the tax-free exchange. The (A), (B), and (C) reorganizations represent in the end only different corporate procedures to produce substantially similar results. The Advisory Group would make uniform the permissible nature of the property to be received in the three types of reorganization, and would further produce similar end results by requiring the transferor corporation to liquidate in a (C) reorganization. As far as they go, these proposals seem eminently sound.

I would propose to the committee that it go measurably further in broadening the scope of the tax-free exchange in reorganization but

that at the same time it give greater protection to the Treasury against converting ordinary income into capital gain and adopt more carefully conceived basis provisions which would make of the tax-free exchange a real continuum and not the fortuitous occasion for untaxed gain or nondeductible loss by reason of inappropriate basis provisions. This could be done, I believe, without loss to the Treasury, and with gain in simplicity of statutory structure and ease of administration. As long as there is a marked difference between the rates applicable to ordinary income and those applicable to capital gain, the threat to the revenues resulting from broadened reorganization provisions comes principally from one or another variation on the bailout the apportionment of bas's and the subsequent realization of capital gain. This is true in the situations which gave rise to the Gregory and Bazley cases as well as in the more recent Chamberlin situation arising from a stock dividend in preferred stock. The elaborate structure of sections 355 and 356 comes largely as a result of the attempt to prevent the conversion of potential dividend income into capital gain. To reduce this hazard with at least equal effectiveness but greater simplicity of method, we can borrow an idea from section 306 but simplify it so that it does not produce the anomalously variant results which now accompany that section; in doing so we can and should apply the simplified version to section 306 itself.

The first step in the proposed revision is to divide, or classify, stock and securities into two classes, the equity and the nonequity, or fixed. Ordinary common stock is, of course, the prime example of the equity security. A debt is, of course, characteristically the nonequity, or fixed, security, but a fixed, nonparticipating preferred stock is equally so. Preference alone would not necessarily make a stock nonparticipating, as it would have under section 312 (b) of the House bill in 1954; a stock participating equally, or even substantially, in earnings along with common stock would be regarded as an equity security. În this connection, we should not be concerned whether stock was voting or nonvoting. As the advisory group has pointed out, this differentiation, which was originated in the 1934 act and carried forward since then, appears to have been ill conceived even for the purposes of the 1934 statute.

Having thus classified securities into equity and nonequity groupings, we could adopt a definition of reorganization at least as broad as that employed prior to 1934 and provide that an exchange of stock or securities of one corporation, a party to a reorganization for stock or securities of the same, or another corporation, a party to the reorganization, could be made without recognition of gain or loss. Gain, of course, would be recognized to the extent of cash or other property received, and it might be received without limitation of percentage or amount; nor would there be any limitation on debt obligations such as is now contained in section 354 (a) (2).

Accompanying this broadening of the reorganization concept and the scope of the permissible exchange would be provisions which it is believed would guard it from abuse. They would be to the effect that if a stockholder gave up an equity security and received in exchange an equity security and one or more nonequity securities, or if he retained an equity security but received with respect to it one or more nonequity securities, there would be no apportionment of basis to

the nonequity securities. The nonequity securities received in such instance would take a basis of zero. Moreover, they would be noncapital assets. And since they would thus be recognized as the potentiality of income, a provision somewhat analogous to section 691 would require that such a security retain its zero basis and non-capital-asset character in the hands of donees or legatees, or others in equivalent positions.

As will be recognized, this would facilitate reorganization transactions by imposing no tax (if there were no boot) at the time of the exchange. On the other hand, it would prevent the conversion of potential ordinary income to capital gain by any variety of the bailout device. The recipient of nonequity securities would have ordinary income to the extent of the amount received when they were disposed of, or otherwise realized upon, but bunching of this income into 1 year, and brackets unusually high for the taxpayer, could be avoided by spreading disposition over 2 or more years. As long as there is a proper continuity of basis with respect to the equity securities exchanged, the revenues suffer little loss by virtue of making the exchange tax free. It may be objected that the more the scope of the tax-free exchange is broadened, the greater the chance that death will overtake the taxpayer before he engages in a taxable realization of his investment, and a new basis will be substituted by virtue of section 1014. This argument is not entirely without force. But the answer is that defense of section 1014 is difficult in any circumstances. If any provision of the statute should yield, it should seem that it would be 1014. In any event, a rational statute cannot be constructed if 1014 is used as a fixed point of reference and all other considerations of legislative policy are required to yield to it.

The special treatment of nonequity securities would not be followed if the taxpayer gave up equity securities and received only nonequity securities. Having liquidated his equity position, he would not be in the bailout position and his basis in the equity securities given up would be transferred to the nonequity securities received, and they presumably would be capital assets in his hands. Similarly, securities received in exchange for nonequity securities would be received without recognition of gain and would take the basis of the securities surrendered.

Analogous provisions would apply to what are now section 355 transactions without the limitations of that section. If a stockholder held stock in one corporation and then, as a result of distribution or exchange of stock or securities of controlled corporations, became the owner of stock or securities of two or more corporations (the old and a new; or two new; etc., etc.), the stock of only one of them—and, of course, only the equity stock of that corporation, if the original holding had been an equity-would take the basis of the stock originally held. Probably the basis should continue with, or be applied to, the equity stock of greatest value in the case of a division giving the stockholder a plurality of corporations in which he held stock. All stock of other corporations which was received or held through the section 355 transaction, equity and nonequity alike, would take a zero basis and a non-capital-asset characterization. If the stockholder wished to retain his investment now divided into two or more corporations, he would be able to do so without tax burden and without par

ticular limitation upon the occasion for the division. If, on the other hand, he wished to realize upon any part of his investment other than that in the one corporation in which his stock would retain basis and capital-asset character, he would do so at ordinary income rates.

Consistency with this plan would presumably require the denial of capital gain treatment to what are now section 346 transactions. There is much to be said for such a result even apart from bringing it into consistency with this proposed reorganization pattern. See Cohen, Surrey, Tarleau & Warren, "A Technical Revision of the Federal Income Tax Treatment of Corporate Distributions to Shareholders," 52 Columbia Law Review, vol. 1, pp. 36-38 (1952). The foundation of pre-1954 judicial decisions which section 346 was said to codify was at best made up of a small number of decisions which by no means necessarily commanded universal or even authoritative assent. Little other than administrative difficulty would be lost by the explicit repeal of section 346 and the questionable rule it was thought to embody.

It need hardly be said that the proposed reorganization treatment would, as the Advisory Group has recommended in its proposals, treat boot equivalent to a dividend as a dividend, without limitation to the gain. The gain limitation in section 112(c) (2) of the 1939 code, carried forward in section 356 (a) (2) of the 1954 code, has, so far as I am aware, never had any discernibly rational basis. It presumably resulted from an error in draftsmanship in 1924 and has been carried forward uncritically since then. I should join also with the Advisory Group in approving the approach to the determination of dividend equivalence of boot embodied in the recent decision of the Court of Claims in Idaho Power Co. v. U.S. (161 F. Supp. 807), as opposed to the more sweeping dictum of the Bedford (325 U.S. 283, 291-292) opinion. If, however, the proposed repeal of section 346 were accepted, this would be of less significance than it is under the existing statute.

As perhaps has been recognized, the proposal which I have made will so far broaden the scope of reorganization as to overrule the judicial doctrine of continuity of interest which was propounded in the Pinellas (287 U.S. 462) and LeTulle (308 U.S. 415) decisions. Though those decisions were thought important Treasury victories in their day, I believe it is now recognized that they were of less significance to the revenue than it was then thought. The gain the taxpayer was held to have realized upon the exchange of property for obligations would in any event have been recognized when the obligations were paid off. For a cash basis taxpayer the time of payment would in any event be the more appropriate time for the recognition of gain. And for an accrual basis taxpayer, it cannot be urged that the Treasury has great stake in accelerating the gain upon an exchange of property for obligations so long as the installment basis is generally available to such taxpayers engaged in transactions not basically dissimilar.

What would have been unfortunate had the transactions in Pinellas and LeTulle been held reorganizations would not have been the

1 I am aware of arguments otherwise made on the basis of what is now sec. 361 (b) (1) (A). They seem to me to lose force in view of the historical function, as I believe it was, of that section to equate the position of the corporation in the statutory merger and in the assets, or (C), reorganization.

47060-59-pt. 3- -7