With me also is Robert Jacobs, formerly a chairman of our tax section's committee on corporate stockholder relationships, who will assist me in answering your questions relating to the net operating loss subject.

At the outset I would like to make three points:

First, the ABA supports title III. Even if no changes were made in it, we would urge this committee to approve it and the Congress to enact it. It is a great improvement on both the present law and on the 1976 amendments which are scheduled to take effect on January 1.

Second, the Tax Section commends the staff, the Chairman, and the committee on the procedure which this bill reflects. It is, in our view, exactly the right way to deal with complex portions of the Internal Revenue Code. We hope that the procedures which began with the installment sale changes some years ago and continued through the subchapter S revision more recently and are now reflected in this Subchapter C Revision Act will continue their steady

course.

Through those procedures, we hope that we can approach much more closely than at present the universally-acclaimed objectives of simplicity, conformity to reasonable expectations, and neutrality in the tax law.

Third, this act promotes all three of those objectives. It eliminates the all-or-nothing aspect of present law relating to net operating losses; it makes the transfer of a loss company a neutral act by according approximately the same value to a loss whether the transaction takes place or not; and, once communicated, the neutrality principle makes all of the necessary line drawing and abuseprevention provisions understandable and predictable.

In short, we are enthusiastically in support of title III of this act. There are only six significant differences between the proposal and statutory language which the ABA approved in February 1985 and the proposed statutory language in the staff report. The ABA respectfully calls attention to these differences and urges that its recommendations be carefully considered by the committee. The five most important differences are:

First, both staff and ABA achieve the neutrality principle by limiting the carryovers to a percent of the purchase price and a number of years during which a loss can be carried forward.

As the previous discussion has indicated, there is a considerable difference between the ABA proposal and the staff proposal in this regard. The ABA proposes 24 percent of the loss each year for five years, while the staff proposes the Treasury rate and a 15-year period. The ABA prefers its proposals because it thinks it more realistically reflects the realities of the business world: businessmen do not think out much beyond a 5-year span, and the rate of return on a company with losses ought to be the equity return and not some kind of a bond return.

Second, we have a difference with respect to the trigger. We both say it should be 50 percent. The staff wants all changes within 3 years to count, and the ABA wants only related changes to count. Third, the concept of the bill requires an anti-stuffing rule, and there is an important difference between the staff proposal and the ABA with respect to debt. The ABA believes that its proposal more

realistically reflects the situation of small companies where, typically, the principal shareholders are also creditors.

Fourth, there is a significant difference with respect to how creditors are treated in loss-workout situations. The staff wants to limit that to a Chapter-11 Bankruptcy Act kind of proceeding, and the ABA would favor a more informal workout along the lines of what section 108 of the code now provides.

Finally, fifth, there is a difference between the style of drafting. It takes the staff 480 lines to draft its proposal; the ABA did it in 210 lines. We think the shorter version is better, because the neutrality principle is sufficiently easy to understand that regulations can flush out the fine points.

Thank you, Mr. Chairman.

Senator CHAFEE. Thank you, Mr. Calkins.
Mr. Aidinoff.

[Mr. Calkins' written testimony follows:]

I

Statement of Hugh Calkins,
Chairman, Section of Taxation
of the American Bar Association
Before the Committee on Finance
United States Senate

September 30, 1985

am Hugh Calkins, Chairman of the Section of Taxation of the American Bar Association. I am pleased to be here to present the views of the American Bar Association on those portions of The Subchapter C Revision Act of 1985 that relate to limitations on net operating losses and other tax attributes, as well as those portions of the report of the Staff of the Committee on Finance ("Final Report") that deal with this subject.1

Before commencing discussion of the subject of limitations on net operating loss carryovers, I would like to comment briefly on the process by which the Subchapter C Revision Act of 1985 has evolved.

The proposals contained in the Revision Act are refinements of earlier proposals contained in a preliminary report ("Preliminary Report") in 1983 by the Finance

1

Staff on the Senate Committee on Finance, "The Subchapter C Revision Act of 1985, A Final Report Prepared by the Staff," 99th Cong., 1st Sess., S. Print 99-47 May, 1985.

2

Committee Staff." We testified at hearings held on October 24, 1983, on the Preliminary Report. Helpful testimony was also received from the Department of the Treasury, other bar associations, practitioners, academicians, and representatives of business. Since then, the Staff has worked in cooperation with the representatives of other Congressional staffs, the Treasury Department, the Internal Revenue Service, and a group of practitioners and academicians to review and improve the proposals in light of the testimony given at those hearings. Members of the Section were invited to participate, and did so actively, in this process. In addition, several of our substantive committees have studied the proposals extensively and our full membership has been exposed to several programs exploring the operation of the proposals.

2

Staff of the Senate Committee on Finance, "The Reform and Simplification of the Income Taxation of Corporations," 98th Cong., 1st Sess., S. Print No. 98-95 (Sept. 22, 1983). The Preliminary Report was based in large part upon recommendations contained in a detailed, thoughtful study prepared by the American Law Institute, recommendations of the Section of Taxation of the American Bar Association, and the other materials cited in the Final Report.

The Final Report is quite detailed, not only explaining the proposals themselves and providing the specific statutory language for the suggested changes to law, but also discussing the respects in which the proposals in the Final Report were and were not modified from the earlier proposals in response to testimony at previous hearings. The Final Report has been published for several months, and in the interim, representatives of the Staff have been forthcoming in discussions of the proposals at meetings of our Section and elsewhere.

We applaud and sincerely appreciate the manner
The pro-

in which these proposals have been formulated.
cess I have just outlined should serve as a model for the
development of legislation of this type. I am confident
that all who took part in this effort believe that the
final product was improved by the contributions of their
colleagues.

We are aware that the changes proposed are fundamental changes which will have a wide impact on business transactions, large and small. Such changes should be

made with caution and with the humility to recognize that, even at this point, none of us sees their full