the extent of all the accumulated earnings and profits of WBOCL-even its less developed country corporation earnings and profits-for all taxable years beginning after December 31, 1962. In other words, the earnings that qualified for capital gain treatment under section 1248(d)(3) as of January 1, 1976, might be retroactively taxed at ordinary income rates under section 1246 because of the procedural failure to exclude income treated under another Code Section.

REASONS FOR AMENDING SECTION 1246

Legislative history

The legislative history of section 1246 shows that the intent of the section was to eliminate tax avoidance schemes employed before 1962 by certain mutual funds." The mutual fund companies were publicly held and conducted no business other than purchase and sale of foreign securities.

Given the specific abuse by certain foreign investment companies to which section 1246 was directed, Congress apparently did not consider the possibility that an operating company that was a less developed country corporation might be treated as one of the targeted foreign investment companies. As a result, there was no study of the need to correlate section 1246's definition of ratable shares of earnings with the section 1248(d)(3) exception for earnings and profits of less developed country corporations such as WBOCL. Notwithstanding this technical oversight, it is clear that Congress did not intend to "entrap" less developed country corporation earnings by the application of section 1246. Therefore, an immediate technical amendment to prevent the retroactive application of section 1246 is consistent with the original intent of the section.

Equity demands an amendment to section 1246

S. 2367 contains a clarifying amendment to section 1246 to prevent its application to some of the proceeds of liquidation of companies like WBOCL. The Staffs of the Treasury and Joint Committees have expressed the belief that passage would be equitable and consistent with sound tax policy. Properly amended, section 1246 would exempt from ordinary income treatment WBOCL's earnings as a less developed country corporation. Such result is in accord with the purpose of section 1246 and recognizes WBOCL's reliance upon section 1248(d)(3) in generating the earnings in less developed countries.

Had WBOCL been liquidated in 1975, section 1248(d)(3) would have expressly provided for capital gain treatment of its earnings and profits. The proposed amendment would insure that the same earnings attributable to active business operations in a less developed country between 1962 and 1976 would not be converted into ordinary income under section 1246 simply because the liquidation occurs after 1975.

Obviously, the amendment will prevent a detriment to any taxpayer having earnings that should not be subject to section 1246. But the rationale for a clarifying amendment applies even more strongly in WBOCL's case when one considers that the repeal of the less developed country corporation exception in 1976 was prospective; and therefore, its lapse should not have a bearing on the treatment of WBOCL's pre-1976 earnings.

CONCLUSION

As described, S. 2367's equitable nature is clear: redressing of an inadvertent omission made by Congress in 1962, generally preventing a retroactive tax under section 1246 and particularly preventing such a retroactive tax upon earnings properly subject to section 1248(d)(3).

4

Senator GRAVEL. Our next witness is Mr. Edward Meislahn.

See H. Rept. No. 1447, 87th Cong., 2d Sess. 5 (1962); President's 1961 Tax Recommendations, Hearings on the Revenue Act of 1962, H.R. 10650, Before the Comm. on Ways and Means, 87th Cong., 1st Sess., Vol. 1, at 35 (1961).

Until enactment of section 1246, earnings of foreign investment companies whose shares were held by U.S. citizens were never exposed to U.S. income tax (with the exception of income from U.S. sources). The companies typically did not pay dividends, and, upon sale of the stock of U.S. citizens, the proceeds, representing primarily the income of the companies, were taxable only at the US. capital gain rate. The purpose of section 1246 is to treat the gain as though it were a distribution of the income from the investments.

The amendment would not provide capital gain treatment to earnings not otherwise qualifying for capital gain treatment. For example, its passage does not grant capital gain treatment under the less developed corporation country exception for WBOCL earnings and profits accumulated after December 31, 1975. Income of WBOCL after 1975 has been subject to Subpart F and to taxation at ordinary income rates.

STATEMENT OF EDWARD H. MEISLAHN, CHAIRMAN OF THE BOARD, FURNITURE RENTAL ASSOCIATION OF AMERICA

Mr. MEISLAHN. First, Mr. Chairman, I would like to say that this might have been called Oregon Day. I have heard from two Senators and a Member of the House and another person from Oregon. Mr. Chairman and members of the subcommittee, my name is Edward H. Meislahn. I am president of Forentco Furniture Rentals which is headquartered in my hometown of Beaverton, Oreg.

I am serving this year as chairman of the board of the Furniture Rental Association of America, which is a trade association with executive offices in Washington, D.C. I very much appreciate this opportunity to appear today on behalf of the FRAA and my company to testify in support of Senate bill 2415.

My prepared statement is in your hands or will be and I will limit my remarks to 5 minutes.

I started Forentco Furniture Rentals in 1968. It is a closely held corporation and I am the major shareholder. Today we have seven showrooms located in our three marketing areas of Portland, Oreg., Seattle, Wash., and the Tri-Cities area of the State of Washington. The furniture we rent is used in houses, mobile homes, offices, model homes for developers, condominiums, and apartments. Most of our customers have average incomes. They include schoolteachers, airlines employees, auditors, executives in training programs, professional athletes, young people starting a home and other individuals having a need for furniture on a more or less temporary basis.

It is a service-intensive industry. The customer needs his furniture right away. He needs a large selection, and all of this creates extensive warehousing costs and extensive delivery costs. Since he rents the furniture for less than 7 months on the average, we need to refurbish and repair. We need to rent the same furniture several times to recoup our costs.

The availability of financing is essential. Unlike retailing, where when you sell, you immediately regain your cost-plus profit, we must carry the inventory for several years.

The Furniture Rental Association of America was founded in 1964. Today the association has 60 members operating in 38 States. Quite frankly, most companies in the industry have always claimed and received investment tax credit on purchases of furniture on the advice of their tax accountants and tax attorneys. One exception was Aaron Rents of Atlanta, Ga., whose claim was denied and who then litigated the issue with the Internal Revenue Service. The association and member companies always viewed the Aaron Rents case as a test case that would finally put to rest any contention by the IRS that our industry should be denied a credit that is available to all other industries. The decision in Aaron Rents was most favorable, but the IRS has refused to follow it.

Unsuccessful then in our attempt to resolve the issue for the industry through the Aaron Rents test case, the association decided that clarifying legislation was the most appropriate solution. More litigation is certainly not the answer. For example, my company does not have enough tax credit dollars at stake to justify the expense of litigation.

S. 2415 would clarify existing confusion over the law. It would confirm congressional intent, would simplify administration of the lodging exclusion, would eliminate further litigation and would have only a negligible revenue effect on the Federal Treasury. I would like to close by thanking you, Mr. Chairman, Senator Packwood, Senator Talmadge and the other members of the subcommittee for holding a hearing on this bill.

[The prepared statement of Mr. Meislahn follows:]

STATEMENT OF EDWARD H. MEISLAHN, PRESIDENT, FORENTCO FURNITURE RENTALS, BEAVERTON, OReg., Chairman of the Board, Furniture Rental ASSOCIATION OF AMERICA, WASHINGTON, D.C.

SUMMARY OF PRINCIPAL POINTS

In 1962, when the investment tax credit and the lodging exclusion were enacted, there were only a few furniture rental companies.

Today, there are approximately 200 firms, generally very 1964, has 60 member companies operating in 38 states.

The members of the industry looked to the Aaron Rents case in Atlanta, Georgia as the test case to resolve the issue of availability of tax credit for furniture rental companies.

The decision in Aaron Rents, issued in September of 1978, was favorable to the industry, but the IRS has refused to follow it.

S. 2415 would clarify existing confusion over the law, would confirm Congressional intent, would simplify administration of the lodging exclusion, would eliminate further litigation, and would have only a negligible revenue effect on the Federal Treasury.

Mr. Chairman, members of the Subcommittee, my name is Edward H. Meislahn. I am the president of Forentco Furniture Rentals, which is headquartered in my home town of Beaverton, Oregon. I am serving this year as Chairman of the Board of the Furniture Rental Association of America ("FRAA"), trade association with executive offices in Washington, D.C. I very much appreciate this oportunity to appear today on behalf of the FRAA and my company to testify in support of S. 2415.

I started Forentco Furniture Rentals in 1968. It is a closely held corporation, and I am the major shareholder. Today, we have seven showrooms located in our three marketing areas: Portland, Oregon; Seattle, Washington; and Tri-Cities, Washington. The furniture we rent is used in houses, mobile homes, offices, model homes for developers, condominiums, and apartments. Most of our customers have average or above-average incomes. They include school teachers, airline employees, auditors, executives in training programs, professional athletes, young people just starting a home, and other individuals having a need for furniture on a more or less temporary basis.

Ours is a service intensive industry. Because a customer generally wants his furniture right away and want to choose from a large selection, we have extensive warehousing costs. Because most rentals are for fewer than seven months, our delivery costs are high. Moreover, we incur substantial costs in refurbishing and repairing furniture each time it is returned, prior to renting the furniture out to a subsequent lessee. Finally, we offer the customer an option to buy the furniture. If the furniture is returned, which may be done with 30 days notice and is generally the case, our cost of selling that used furniture is naturally quite high.

The availability of financing is essential to our business. A furniture retail business, which most of ur are familiar with, quickly recoups the cost of furniture purchased for inventory as soon as a sale is made. Even if the sale is made on credit, the contract can be sold for immediate cash. For us, however, recoupment of investment costs usually requires renting the same piece of furniture to more than one customer. Naturally, the cost of financing our inventory has skyrocketed in the past year, as the prime rate has reached record levels.

The furniture rental industry is a fairly new one. Most companies have begun operations during the past ten years. Prior to 1962, the year that the investment tax credit provisions were enacted, there were only a handful of companies in the United States that rented residential furniture. Today, there are approximately 200 firms, most of which are very small operations, with one to three showrooms. My company is quite typical of others in the industry. There are a few very large national companies, but they are the exception.

The Furniture Rental Association of America is also new. Founded in 1964, the Association's government relations activities did not get under way until seven or eight years ago. Today, the Association has 60 member companies, which are believed to represent 80 to 85 percent of the furniture rental showrooms in the country. Members of the Association rent furniture in at least 38 states.

Quite frankly, most companies in the industry have always claimed investment tax credit on purchases of furniture. This has been upon the advice of their tax accountants and tax attorneys, who have advised them that the investment tax credit is available for purchases of furniture, irrespective of which category of customer might subsequently lease it. In the past the Service generally did not reject these investment tax credit claims. One exception was Aaron Rents, of Atlanta, Georgia, whose claim was denied and who then litigated the issue with the Internal Revenue Service. The Association and member companies always viewed the Aaron Rents case as the test case that would finally put to rest any contention by the IRS that our industry should be denied a credit that is available to all other industries. The decision in Aaron Rents was most favorable. The judge held that the investment tax credit is available for furniture rented to apartment tenants, but is not available where rented to apartment owners. In the industry, on the average, of all furniture rented to apartment tenants and apartments owners in 1979, approximately 92 percent was rented to tenants and 8 percent to owners. And the trend is toward even more rentals to tenants and even fewer rentals to owners.1

Contrary to our expectations, the Internal Revenue Service has not followed the Aaron Rents decision. Instead, it issued a Revenue Ruling stating that investment tax credit is not available with respect to furniture leased to either apartment owners or apartment tenants.

Unsuccessful, then, in our attempt to resolve the issue for the industry through the Aaron Rents test case, the Association decided that clarifying legislation was the most appropriate solution. More litigation is certainly not the answer. For example, my company does not have enough tax credit dollars at stake to justify the expense of litigation. That is the situation for all but a few companies in the industry, some of whom do not even claim the credit because they depreciate their furniture in fewer than three years.

In seeking this legislation, the Association does not believe it is asking for any special treatment from Congress. Rather, it is asking not to be arbitrarily singled out for unfair treatment. When the investment tax credit bill and the lodging exclusion were first enacted in 1962, my company and this Association did not exist. I am sure that no one in Congress considered whether furniture rental companies would be denied the tax credit on the basis of the "lodging exclusion." The question that arises in my mind and in the minds of my competitors is what good reason is there for denying us a credit that is generally available to all other businessmen. We feel that our investments in furniture deserve the same consideration and treatment as investments in other industries. In any event, the Internal Revenue Service agrees that we are entitled to the credit when we rent furniture for use in offices, homes, condominiums, mobile homes, and hotel and motels. Why is it that we should not receive the credit when our furniture is rented to an apartment owner or an apartment tenant? To us, the Internal Revenue Service's position is illogical and unfairly penalizes the members of our industry. We believe that the enactment of S. 2415 is required to eliminate this unfairness.

I would like to close by thanking the Chairman, Senator Packwood, Senator Talmadge, and the other members of the Subcommittee for holding a hearing on this bill. We assure you that the bill is of great important to our industry. Its enactment will lead to expansion and increased employment, not only in our industry, but in the furniture manufacturing industry as well. On the other hand, if the Treasury's position on this issue prevails, we can expect a contraction of the furniture rental industry and a resulting loss of jobs.

These figures were derived from a survey of our membership at the beginning of 1980, which we conducted at the request of Senator Packwood. An explanation of the trend is set forth in a letter I wrote to Senator Packwood on January 11, 1980, which is attached to my statement.

WASHINGTON, D.C., January 11, 1980.

Re investment tax credit bill.

Hon. BOB PACKWOOD,

U.S. Senate,

Dirksen Senate Office Building, Washington, D.C.

DEAR SENATOR PACKWOOD: This is in response to your inquiry concerning the proportion of furniture rented directly to apartment tenants versus that rented to apartment owners.

As you know, in the Aaron Rents tax case, Judge Freeman ruled that under current law the investment tax credit is available with respect to furniture purchased for subsequent rental to apartment tenants, but that it is not available where the furniture is rented to apartment owners. Furniture rented neither to an apartment owner nor to an apartment tenant was not at issue in the litigation, inasmuch as the Internal Revenue Service acknowledges that such furniture is not subject to the "lodging exclusion."

The Aaron Rents case involved tax years 1972-1973. At that time, 32 percent of Aaron Rents' total rentals to apartment owners and apartment tenants was to apartment owners and 68 percent was to apartment tenants. In subsequent years, however, Aaron Rents' business has shifted toward tenants and away from apartment owners. Today, 92 percent of Aaron Rents' total rentals to apartment owners and tenants is rented to tenants and only 8 percent is rented to apartment owners. The experience of Aaron Rents is typical of that of the industry. Based on a recent telephone survey of 21 FRAA members, approximately 90 percent of rentals are to tenants versus 10 percent to apartment owners and operators. Only two of these 21 companies rent less that 90 percent to apartment tenants; for over half of the surveyed companies, the proportion of rentals to apartment tenants is 95 percent or greater.1 According to members of the industry, the trend is toward more rentals to tenants and fewer rentals to owners.

The trend away from rentals to apartment owners in favor of rentals to tenants is unrelated to investement tax credit considerations or the Aaron Rents decision. The present trend is expected to continue irrespective of the outcome of our bill or the outcome of future litigation.

Several reasons for the trend have been cited by members of the industry. First, during the 1974 recession, some rental companies had bad experiences with developers and apartment owners who had rented furniture, but who were financially squeezed and unable to meet their rental obligations. Based upon that experience, most rental companies prefer to deal directly with tenants.

Second, in the past, when there were relatively few furniture rental showrooms in the country, it was difficult to attract tenant's business, because they often lived far away from the nearest furniture rental showroom. Now, however, with many more showrooms in convenient locations, it is much easier for furniture rental companies to attract the tenant's attention. Moreover, the tenant's preference is to rent directly from the furniture rental company so that he can choose from a varied selection. The tenant's flexibility is greatly reduced where the apartment owner supplies the furniture. As tenants have become more and more aware of the selection available from furniture rental companies and the convenience of renting furniture, they have become more inclined to select apartments where they will be able to rent the furniture directly from the furniture rental company, rather than accepting that which has already been selected by the apartment owner.

Finally, the apartment owner who wishes to provide furnished lodging has an economic incentive to purchase, rather than to rent, the furniture. By purchasing, the apartment owner avoids the passed on cost of the rental company's delivery system, warehousing, financing, and general administrative expenses. Thus, if he seeks to make a profit by renting furniture to tenants, he is likely to purchase the furniture. If, on the other hand, he offers the furniture to his tenants merely as a convenience, he is more likely to place the prospective tenant in contact with the furniture rental company, so that the tenant will have the advantage of a greater selection and so that the apartment owner will avoid the cost and inconvenience of acting as an intermediary.

The staff of the Joint Committee on Taxation estimated last year that if H.R. 3244 were enacted in 1979, $2 million in additional investment tax credit would be claimed with respect to furniture purchased by the furniture rental industry in 1980. A major assumption of that analysis is that absent the enactment of H. R. 3244, no furniture rental company would receive investment tax credit on purchases

The FRAA will supplement this data as soon as it receives written responses to a questionnaire to FRAA members directed to this issue.