OPENING STATtement of SenATOR DOLE, HEARING ON SUBCHAPTER C

Mr. Chairman, you have brought to the committee a very distinguished group of witnesses to comment on the staff recommendations to improve the corporate tax provisions of the Internal Revenue Code. Subchapter C of the Code is not known for its simplicity or its coherence. I hope these hearings may be an important step in reform. With the Ways and Means Committee beginning its tax reform markup and our committee's efforts not far ahead, this hearing is certainly timely.

I think it may be useful to describe some of the background behind the staff project. In 1982, while I was chairman, we included as part of the Tax Equity and Fiscal Responsibility Act a few fundamental modifications of the corporate tax rules, and closed certain corporate tax loopholes. One of the more significant changes was a provision involving liquidations suggested by Senator Danforth. During consideration of those changes, a number of groups criticized the committee for moving too quickly. I can recall the ABA representative urging us to slow down, take two years to study subchapter C, consult with them, and reform the rules correctly. Later that year, I asked the committee staff to do precisely that, and to report their suggestions to the committee.

Well, the staff has taken more than two years to study the subject, and has consulted with representatives of the ABA and a number of other professional organizations and individuals on a regular basis. Where we had consensus, we added several proposals to the Deficit Reduction Act of 1984. Other issues deserved, and received, additional analysis. I know that a distinguished representative of the ABA is here today to express his group's views on this project, and I will be particularly interested in hearing his views on the process culminating in the final staff report. There are those here who will urge the committee to study this area further. Now, we are not adverse to studying a subject carefully, and we try not to act precipitously when we enact legislation. But it seems to me, at some point, we have to differentiate between those who really believe more study is necessary, and those who just don't like the proposals.

As it is, this is probably the slowest moving, most-studied tax legislative project we have had in some time. Some proposals barely get one hearing; this proposal will have had at least two. Some proposals often are not presented to the public in the form of legislative language; in this one, such language has already been drafted and published. Some proposals offer minimal explanatory background material; this proposal cannot be faulted on that ground. Some proposals are enacted very quickly; this proposal has already had almost three years of study, and is based largely on an American law Institute study spanning eight years before that.

Now, I have an open mind as to whether we should move ahead with this. But at some point, we must make a decision, we cannot just study a project to death. We must decide whether this is an improvement over current law. If it is, then perhaps it is time to move ahead with it. If it is not, then perhaps we should drop it altogether and move ahead without it.

Two final comments. First I'm sorry that we could not accommodate everyone who requested to testify at this hearing. I understand that there was a long list of requests and because of time constraints, we could not include everyone. I would encourage those who requested to appear and who did not make the witness list to submit written testimony to the committee. It will be reviewed as carefully as the testimony of those appearing here today.

Second, I would like to publicly thank the following tax practitioners and academicians who contributed much time and effort to this project. They are Bernard Aidinoff of New York City; Donald Alexander of Washington, D.C.; William Andrews of Cambridge, Massachusetts; Frank Battle of Chicago; Herbert Camp of New York City; Jerold Cohen from Atlanta; James Eustice of New York City; Peter Faber of New York City; Martin Ginsburg of Washington, D.C.; Fred Goldberg of Washington, D.C.; Harold Handler of New York City; James Holden of Washington, D.C.; Robert Kacobs of New York City; Howard Krane of Chicago; Robert Lawrence of New York City; Richard May of Washington, D.C.; Willard Taylor of New York City; and Mark Yecies of Washington, D.C.

In addition, I would like to thank Jim Dring, Jack Sterling, Paul Jacokes, Harold Hirsch, and Labrenda Stodghill of the Joint Committee Staff; Rick D'Avino and Eric Elfman of the Treasury staff; Jerry Mason and Marc Blumkin from the IRS; Jim Fransen from Legislative Counsel's Office; and Bill Wilkins, Andre Le Duc, and George Yin of our staff, who all helped in putting this project together.

I can't think of a more outstanding group of tax professionals to assist on a project of this nature, and the committee thanks you.

Senator CHAFEE. Good morning, everybody. Today we are having a hearing on the proposals to revise subchapter C of the Internal Revenue Code. We have Mr. Pearlman followed by four panels.

I have a statement here from Senator Dole which I will read in its entirety, because this really states my views as well:

"You have brought to the committee a very distinguished group of witnesses to comment on the staff recommendations to improve the corporate tax provisions of the Internal Revenue Code. Subchapter C of the code is not known for its simplicity or its coherence. I hope these hearings may be an important step in reform. With the Ways and Means Committee beginning its tax reform markup and our committee's efforts not far ahead, this hearing is certainly timely.

"I think it may be useful to describe some of the background behind the staff project. In 1982, while I was chairman, we included as part of the Tax Equity and Fiscal Responsibility Act"-socalled "TEFRA"-"a few fundamental modifications of the corporate tax rules, and closed certain corporate tax loopholes. One of the more significant changes was a provision involving liquidations suggested by Senator Danforth. During consideration of those changes, a number of groups criticized the committee for moving too quickly. I can recall the ABA representative urging us to slow down, take 2 years to study subchapter C, consult with them, and reform the rules correctly. Later that year, I asked the committee staff to do precisely that, and to report their suggestions to the committee.

"Well, the staff has taken more than 2 years to study the subject, and has consulted with representatives of the ABA and a number of other professional organizations and individuals on a regular basis. Where we had consensus, we added several proposals to the Deficit Reduction Act of 1984. Other issues deserved, and received, additional analysis. I know that a distinguished representative of the ABA is here today to express his group's views on this project, and I will be particularly interested in hearing his views on the process culminating in the final staff revort.

"There are those here who will urge the committee to study this area further. Now, we are not adverse to studying a subject carefully, and we try not to act precipitously when we enact legislation. But it seems to me, at some point, we have to differentiate between those who really believe more study is necessary, and those who just don't like the proposals.

"As it is, this is probably the slowest moving, most-studied tax legislative project we have had in some time. Some proposals barely get one hearing; this proposal will have had at least two. Some proposals often are not presented to the public in the form of legislative language; in this one, such language has already been drafted and published. Some proposals offer minimal explanatory background material; this proposal cannot be faulted on that ground. Some proposals are enacted very quickly; this proposal has already had almost 3 years of study, and is based largely on an American Law Institute study spanning eight years before that.

"Now, I have an open mind as to whether we should move ahead with this. But at some point, we must make a decision, we cannot just study a project to death. We must decide whether this is an

improvement over current law. If it is, then perhaps it is time to move ahead with it. If it is not, then perhaps we should drop it altogether and move ahead without it.

"Two final comments. First, I'm sorry that we could not accommodate everyone who requested to testify at this hearing." And I must say, when you look at the list, we have done pretty well. We are going to be here a while.

"Those who requested to appear and who could not be on the witness list are urged to submit their written testimony to the committee," where it will be studied carefully, as well as the testimony of those who appear here.

Let me say this to start with: Everybody's testimony will be part of the record today, so you don't have to ask; that is automatic.

"Second, I would like to publicly thank the following tax practitioners and academicians who contributed much time and effort to this project," and that is the study group that put this green book together. "They are Bernard Aidinoff of New York City; Donald Alexander of Washington, DC.; William Andrews of Cambridge, MA; Frank Battle of Chicago; Herbert Camp of New York City; Jerold Cohen from Atlanta; James Eustice of New York City; Peter Faber of New York City; Martin Ginsburg of Washington; Fred Goldberg of Washington; Harold Handler of New York City; James Holden of Washington; Robert Jacobs of New York City; Howard Krane of Chicago; Robert Lawrence of New York City; Richard May of Washington; Willard Taylor of New York, and Mark Yecies of Washington.'

It looks like Washington and New York kind of had a grip on this thing, doesn't it? How did those fellows from Atlanta and Chicago sneak in here? Well, we're broadbased. [Laughter.]

Senator CHAFEE. "In addition, I would like to thank Jim Dring, Jack Sterling, Paul Kacokes, Harold Hirsch, and Labrenda Stodghill of the Joint Committee staff; Rick D'Avino and Eric Elfman of the Treasury staff; Jerry Mason and Marc Blumkin from the IRS; Jim Fransen from legislative counsel's office; and Bill Wilkins, Andre Le Duc, and George Yin of our staff, who all helped in putting this project together.

ting

"I can't think of a more outstanding group of tax professionals to assist on this project," and the committee thanks each and every one of you for helping out.

So, let's move ahead now with Mr. Pearlman, Assistant Secretary of the Treasury.

We welcome you here, Mr. Pearlman. Please go ahead.

STATEMENT OF HON. RONALD A. PEARLMAN, ASSISTANT SECRETARY FOR TAX POLICY, DEPARTMENT OF THE TREASURY, WASHINGTON, DC

Mr. PEARLMAN. Thank you, Mr. Chairman. Good morning. This is our second opportunity to appear before the committee on the subject of the basic reform of the taxation of corporations and shareholders. We first appeared back in October 1983 before the full committee to comment on the preliminary staff report, and we are pleased to be here this morning to testify in connection with the subcommittee's hearings on the final staff report.

Let me begin by expressing, as we did previously, our support for the committee's efforts to undertake a serious review and reform of subchapter C. I think the work of the working group and of the Finance Committee staff and others who have been involved in this process over the last several years, in connection with both the preliminary and final reports, has simply been outstanding. It has contributed significantly to the reform process, and our hats at Treasury are off to all of those who have participated.

Senator CHAFEE. Now drop the other shoe. [Laughter.]

Mr. PEARLMAN. Our reactions to the final report, as you implied by your comment, are mixed. My main focus this morning is going to be on the net operating loss carryover rules, but let me briefly comment on the remainder of the other proposals, principally those relating to acquisitive reorganizations and purchase transactions and related transactions.

First, we think extensive changes in subchapter C simply cannot be viewed in a vacuum, and I know the committee and I think the staff shares that view, but must be viewed in light of substantial legislative activity over the past several years and the prospect of significant additional legislative activity in connection with fundamental tax reform.

The relative importance of changes to subchapter C versus other tax legislative changes obviously is going to be the subject of legitimate debate. Our view is that broad changes in subchapter Care not essential to the fundamental tax reform project and should follow the Congress's review of fundamental tax reform rather than precede it.

We continue to be concerned, as we have expressed over the last couple of years, with the potential economic effects of the broad changes to the acquisitive reorganization provisions. I don't mean to say that in any negative way. I don't mean to presuppose what those economic effects are, but simply that we think there is a potential for very significant economic effects on merger and acquisition activity in this country, and that it is essential for this subcommittee and for the Finance Committee to take those effects into consideration.

I think the step the subcommittee is taking this morning, of including for the first time in the deliberation, as I am told, some input from two distinguished economists, will aid significantly in evaluating those economic effects. But I think this is an area where we should be very careful that we, as technicians, not let our interest in making sure that the statute is improved, made more workable, and all the other wonderful things we can do with it, not also be impacted and influenced significantly by careful and deliberate economic analysis.

What I would like to do in the short time that we have this morning is turn to the portion of the staff report dealing with the carryover of net operating losses and other tax attributes.

Mr. Chairman, because we have submitted a rather lengthy written statement on this subject, I am not going to do anything more than summarize our reactions to the report. I will refer the subcommittee to the written statement for the background, but I would like to take few minutes to comment on the more salient pieces of the net operating loss proposals.

First, let me say that this is an area where we believe prompt legislative action is important. In 1976, as you are aware, Congress sought to reform the loss-carryover rules. In our judgment, the current law is unsatisfactory, and I think it is fair to say that there is a general consensus that that is the case, although that is not the uniform view.

The 1976 act produced rules that were both complex and controversial. The effective date of those changes has been repeatedly delayed, most recently by the 1984 act, to January 1, 1986.

Because we believe the current law is unsatisfactory and because we believe there has been considerable constructive effort to develop a set of permanent net operating loss rules that are getting very close to the point where they can be considered for enactment, we urge the subcommittee to proceed with the net operating loss aspects of these proposals.

Let me say, in that regard, that we are very strongly supportive of the staff's proposed approach on loss carryovers; we think it can serve as the basis for enacting loss carryover rules. I think it is significant that there seems to be some consensus developing that we are reaching a time when Congress can act on loss carryforwards. Not only do we have a staff report in which we are pleased to come up and say we are in strong support, but the Ways and Means Committee staff recommendations on fundamental tax reform also included essentially the approach recommended by the Finance Committee staff and working group.

Senator CHAFEE. Do you mean they dealt with the net operating losses?

Mr. PEARLMAN. That is correct.

Senator CHAFEE. And that is all?

Mr. PEARLMAN. And that is all. That is correct.

Senator CHAFEE. And did it do just as the staff report recommended?

Mr. PEARLMAN. Well, not "just as." There are some changes, but not dramatic changes. I would say it is fair to say that, essentially, the Ways and Means staff recommendation is the same as the Senate Finance Committee staff report.

Again, because of our ability to try to be as supportive as we can, and an indication that there is interest in some consensus in both the staffs of the Ways and Means and the Finance Committee, I would suggest that this is an issue that is ready to be taken to the membership of the subcommittee, and I would encourage you-because I think it is a very important issue-I would encourage the subcommittee to proceed with that, with at least that aspect of this report.

The staff report has a loss carryover rule, applicable following acquisitions of loss corporations, which seeks to limit the use of net operating loss carryforwards by determining the value of the loss corporation and then trying to determine the assumed future earning stream on that value.

The report adopts a single rule, which is consistent at least with the suggestion that we made in our 1983 testimony. We acknowledge the single rule is not as theoretically precise as the separate rules that apply to mergers and purchase transactions, but we do